When it comes to retirement, deciding how to use your pension savings can feel like a big decision. Working out how much money you’ll need, and for how long, isn’t easy.
Taking tax-free cash is most people’s first thought. But once you’ve decided what to do with that tax-free cash, you’ll need to consider how to use the rest of your retirement savings. One option is an annuity, which can provide a regular income for life.
For some people, an annuity can help remove one of the biggest retirement worries: running out of money.
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How does an annuity work?
An annuity is a product designed to pay you a regular and lifelong income during retirement. This is usually paid monthly, quarterly, half-yearly or annually, depending on your preference.
When you buy an annuity, you hand over your money to an insurance company or pension provider and exchange some or all of your pension savings for an annuity.
In return, the provider pays you an income based on:
- How much money you invest
- Your age
- Your health and lifestyle
- Current interest rates
- The type of annuity you choose
What are the advantages of an annuity?
- Guaranteed income – an annuity can provide peace of mind because it pays a guaranteed income based on the terms you choose.
- Predictable payments – with an annuity you know exactly how much income you’ll receive, which can make it easier to budget and plan ahead.
- Less ongoing management – unlike investments, annuities don’t require regular monitoring or investment decisions.
- Income for life – lifetime annuities continue paying an income no matter how long you live. This can be especially valuable later in retirement – even if you live beyond 100, your income will continue.
- Choice over how you use your pension savings – you don’t have to choose between buying an annuity or keeping your pension invested. Some people use part of their pension savings to secure a guaranteed income and leave the rest invested or accessible through other retirement income options.
- Options for loved ones – you can choose features that continue payments to a spouse or partner after your death or help protect the value of your annuity for your beneficiaries. Depending on the options and features selected, beneficiaries may receive up to the full value used to buy the annuity, and in some cases more.
What are the disadvantages of an annuity?
- Rates can change depending on availability – annuity rates can move over time. The income you receive depends on the rates available at the time you buy an annuity.
- It may take time to recover your original pension value – depending on how long you live, it could take several years before the total annuity payments exceed the amount you originally saved in your pension pot.
- Extra features can reduce your income – adding options such as inflation protection or payments for a spouse or partner will usually lower the starting income. However, there is always a trade-off with this as these features can provide valuable benefits, and in some cases the impact on income may be smaller than you might expect.
- Usually irreversible – most annuities aren’t flexible and cannot be changed or cancelled once set up. This means they may not suit changing circumstances later on.
- Inflation risk – unless you choose an increasing annuity, your income stays the same each year. Over time, inflation may reduce what that income can buy.
- Limited investment growth – once you buy an annuity, your income is not linked to stock market performance. This means you won’t benefit from investment growth, but you won’t be affected by market falls either.
Why do people buy annuities?
With an annuity, you’re exchanging some or all of your pension savings for a regular income. People often choose an annuity for that reason because they can provide certainty and security during retirement, helping to reduce worries about running out of money later in life.
Annuities can also make it easier to budget because you know how much you’ll receive each month. Some people use an annuity to help cover essential living costs such as household bills, food and travel, giving them greater confidence in managing their finances during retirement.
For many people, the main attraction of an annuity is the peace of mind that comes from knowing they’ll continue to receive a regular income throughout retirement.
How do you buy an annuity?
You can usually buy an annuity using money from your pension once you reach the normal minimum pension age. This is currently age 55 and is due to rise to 57 from 2028 – unless you have a Protected Pension Age of 55.
The process normally involves:
- Deciding how much of your pension savings to use
- Comparing quotes from different annuity providers
- Choosing the type of annuity and any extra features
Before buying an annuity, you can usually take up to 25% of your pension tax-free, up to your remaining lump sum allowance. However, this reduces the amount left to provide a guaranteed income.
Shopping around different annuity providers is important because different providers can offer different income levels. Your pension provider may also provide annuity options.
Fidelity does not provide annuities directly but has partnered with HUB Financial Solutions. HUB can help customers understand the available annuity options and compare quotes from different providers.
Is an annuity right for you?
An annuity can provide security and certainty in retirement, but it may not be right for everyone. The best option will depend on your circumstances, income needs and retirement plans.
The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944. The website also features an annuity comparison tool, the tool can help you search the market to see how much income you could get from a guaranteed income for life, or fixed term. As well as showing you how all the providers on the market compare.
At Fidelity, our retirement specialists are able to provide both guidance and advice around your retirement options. If you would like personalised advice based on your individual circumstances, our advice service is also available to customers with £100,000 or more to invest (including pensions). It starts with a free, no-obligation conversation to determine whether the service is right for you.
To find out if an annuity is right for you, please see our Annuities page here.
FAQs
If you’re still not sure if an annuity would suit you, have a read over our FAQ section which includes some other commonly asked annuity questions.
