If you’re approaching retirement and have been paying into your pension fund for the past 10, 20 or even 30 years, you might be wondering how that turns into an income for your retirement. Well, in most cases, you swap that pension pot for an annuity.
What is an annuity?
An annuity is a type of insurance policy, designed to provide you with a monthly income throughout your retirement. The type of annuity and the rates at the time will decide how much you receive. In general, the more money in your pension pot the higher the annual income in retirement.
When does it happen?
You can buy an annuity when you retire, but you don’t have to do it straight away. You do have the choice to hold off until you’re 75, as other options, such as pension drawdown may be more attractive at the time.
Do I have to buy an annuity?
Yes. The government allows you to delay buying an annuity but unless your pension pot is worth less than £18,000, you’re unable to get it all as a cash lump sum. When you reach the age of 55 you have the option to unlock up to 25% of your pension as a cash lump sum but the remainder must be used to purchase an annuity by your 75th birthday.
Types of annuity
There are a number of different types of annuity, including:
- Level annuity – designed to provide the same annual income for the rest of your life. This is the most common as it is safest way to guarantee an income.
- Increasing – this provides you with more money each year, usually increasing by an inflation-linked rate
- Investment – the amount received each year will depend on the return of the investment, which is usually managed by the annuity provider
- Enhanced – if you have any existing medical conditions, or are a smoker, you might be able to receive a higher income due to the decreased life expectancy.
To find out which type of annuity will provide you with the best source of income, take a look at the Money Vista annuity calculator.
Buying an annuity
Annuities are available from your pension provider, but this is rarely the best available option. In order to get the most for your money, it’s absolutely essential that you exercise the right to the Open Market Option (OMO). This is part of the UK Finance Act and means that you are allowed to shop around for the best rates.