A pension annuity converts your pension pot into a guaranteed income for the rest of your life. You can use all or part of your pension to buy an annuity from an insurance company.
How do annuities work?
The income you receive from a pension annuity depends on your age, the size of your pension fund, and in some cases, your state of health. Once you buy an annuity, you’ll no longer have any say over how your pension is invested – but you’ll have the security of knowing your income will continue for the rest of your life.
Some options will reduce the starting level of income you can get, but they can provide valuable benefits – for example, protection against inflation, or payments that continue after your death.
Buying an annuity is an irreversible decision, so it’s really important you shop around and compare different annuity rates for the options you need.
What are the different types of annuities?
You can select different options when you buy an annuity. These options must be chosen at the start and can affect the level of starting income you can get. What is best for you will depend on your personal circumstances.
Traditional lifetime annuity options
Level or increasing income
You can choose whether the level of income will stay the same, rise as a fixed percentage, or with inflation.
Choosing inflation protection will protect the value of your annuity income over time but mean a lower starting rate. If you choose a level income annuity, keep in mind that inflation might erode what you can buy with that income over time.
Protection for your loved ones
You can choose an annuity with a guarantee period of up to 10 years. If you die within the guarantee period, then your pension can continue to be paid to your estate or a chosen beneficiary for the remainder of that time.
Joint-life annuities will pay your spouse, civil partner (or other financial dependant) an income after you die and they outlive you. This can be at the same income level, or at a reduced amount, for example 50% or 66% of the annuity income paid to you.
Make sure you give full details about your health status and history. If you drink, smoke or have certain health issues, it can boost the annuity rates you are quoted. For more serious conditions that limit your life expectancy, you might be eligible for an ‘enhanced’ annuity.
Flexible annuities
These annuities allow your starting income to decrease as well as increase. If you choose this option, then it will be stated in the contract when you start the annuity. Flexible annuity rules also allow guarantee periods to be longer than 10 years and for a nominee’s pension to be included, not just a dependant's. If you purchase a flexible annuity, you’ll trigger the money purchase annual allowance (MPAA). This can restrict the amount you can pay into certain types of pension in the future.
Do you pay tax on annuities?
All annuity income is taxable, in the same way as earnings. The amount of income tax you pay will depend on your other income for the year.
How do I buy an annuity using my SIPP?
To start the process of buying a lifetime annuity – with us paying your tax-free lump sum – you'll need to log into your account online and access 'Manage my SIPP'.
Looking to transfer part, or all, of your Self-invested personal pension (SIPP) to an insurance company to buy an annuity, and want them to pay any tax-free lump sum? Please contact us for a transfer-out form.
What happens to my annuity when I die?
This depends on the options you choose. If you’ve chosen a guarantee period, then income will continue to be paid to your estate or beneficiaries until that guaranteed period ends.
A joint annuity will continue to pay income to your beneficiary at the level selected. This might be 50%, 66% or 100% of the income you were receiving, depending on the option you originally chose.
If you don’t choose any death benefit options, the income will stop when you die.
Disclaimer: These articles are for information purposes only and are not a personal recommendation or advice. You should consider consulting a regulated financial adviser or a tax adviser if you’re in any doubt about what to do. Tax and pension rules apply.
An AJ Bell SIPP gives you complete flexibility on how much you save for retirement, and allows you to decide when and where your pot is invested.
You've saved hard for your retirement, but once you get there, what are your options?
Written by:
Charlene Young
Pensions and Savings Expert
Charlene Young is AJ Bell’s Pensions and Savings Expert. She joined AJ Bell in 2014 from a wealth management firm where she worked with private clients and small businesses as a financial planner.
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