A READER has been told that they have the option to purchase an annuity with their pension funds at retirement and has asked what an annuity is.
An annuity is a financial product where you give a lump sum of money to an insurance company and, in return, they pay you a regular income, often during retirement.
For example, you use your pension pot at retirement to purchase an annuity and the insurance company will pay you a monthly pension for the rest of your life.
The amount of income you receive will depend on factors such as your age, health, any options you choose (for example, whether you want your income to increase while in payment) and financial conditions at the time of purchase.
One of the key benefits of an annuity is protection against living for longer than expected. Many people underestimate how long they may live in retirement. An annuity removes the risk of running out of money by paying a guaranteed income for as long as you live.
Therefore, if you live significantly longer than average, you could receive far more in total payments than you paid as a premium.
Certain health conditions or a reduced life expectancy may qualify you for more generous terms. For this reason, it is in your interest to disclose any relevant health conditions when seeking quotations.
One disadvantage of a standard annuity policy is that there may be little or no value left over after you die. However, there are options to mitigate this. For example, you can purchase a guarantee period where your regular income payments will continue for a specified period even if you die. You can also select a pension to continue to be paid to your spouse/partner after your death, although this will usually result in a lower starting income.
You do not have to use all your pension funds to buy an annuity. Many retirees combine an annuity with more flexible kinds of retirement income. In addition, you may be able to take up to 30% of your pension savings as a tax-free lump sum before purchasing an annuity.
Income from annuities is taxed when you receive it, just as it is with wages or your state pension. The transaction where you exchange your funds for an annuity policy is not taxed.
