Buying an annuity: annuity options and shopping around

There are many different options when buying an annuity, which allows you to tailor your income to suit your needs.

It's important to understand what these options are. This is so you'll know:

• when you’ll get your income
• how much you’ll get
• what you can protect
• who you can potentially provide for when you die.

When you’ve chosen which type of annuity you’ll be buying, there are some decisions you’ll have to make that will help personalise the product for you and make sure it’s right for your situation.

There are several options to choose from:

You’ll need to decide whether you want the annuity to pay out to someone after you die.

A single life pension is only paid for your lifetime and will stop when you die.

It usually pays a higher level of income than a joint life annuity. It might suit you if you don’t have any financial dependants.

A joint life annuity also provides an income for your spouse, civil partner or other dependant after you die.

This provides a continuing income – which is usually expressed as a percentage from 1-100% of the income that you were receiving immediately before your death.

For example, 50% or 25% of the income you were receiving will be payable after your death.

A joint life annuity will often pay out a lower regular income than a single life annuity, as it’s assumed that the pension would need to pay out over a longer period. However, this isn’t always the case.

Some providers might not agree to set up a retirement income for a spouse or partner if they’re more than ten years younger than you.

It might suit you if your partner, or someone who’s financially dependent on you, won’t have much income of their own after you die.

If you are in a long-term relationship, the financial decisions you make now could affect both of you for the rest of your lives.

So it's worth discussing these questions with your spouse, partner or dependant:

• Does my spouse/partner/dependant have a pension?
• Will they have guaranteed income of their own?
• Will their income be enough for them to manage financially after I die?
• If my spouse’s/partner’s/dependant’s health is poor, does it make more sense to have higher income assured now?
• What happens if they die before I do?

One of the main choices you need to make is whether to choose an income that stays the same every year (remains fixed) or one that increases each year. 

This means you’ll get the same pension payments each year for the rest of your life.

You’ll initially get a higher income, but its buying power will go down over time.

This means that over time you’ll be able to buy less with your income as the prices of things such as food and energy go up.

To help protect your income from rising prices, you can choose an increasing retirement income. This is sometimes called an escalating annuity.

With increasing income, you have two choices:

• An income that goes up each year at a set rate – usually 3% or 5%.
• An income that’s adjusted each year in line with inflation – index linked

With index linked, if prices fall, your retirement income would also fall. But generally, whether your income goes up or down, its buying power will stay the same.

However, some providers will cap inflation increases – to 3%, for example – and only allow your income to go up by 3% even if inflation is higher.

Your initial income will be lower, but will increase over time. This allows you to maintain the purchasing power of your money. 

With an increasing retirement income, if you choose a high annual rate of increase your starting income will be a lot lower than you would get from a level retirement income

While a level income might seem tempting because it pays out more to start with, most people live on their retirement income for at least 20 years. And in the last ten years, inflation has caused prices to rise by an average of 3-4% a year.

If you die soon after taking out an annuity, it won’t have paid out much.

A guarantee period is a form of protection that ensures that your income continues to be paid out for a minimum term, even if you die within that term.

If you buy a ten-year guarantee for example, and die after seven years – payments will continue for another three years or a lump sum can sometimes be paid.

If you die after the guarantee period you’ve selected, the income will stop – unless you’ve set up a joint life annuity.

Providers typically limit guarantees to a maximum of 30 years.

The impact on your annuity rate will vary depending on your age, gender, the length of the guarantee and whether you’re setting up a joint life annuity.

This is another form of protection that can provide a lump sum to your beneficiary if you die before you’ve had back, as income, the full amount used to buy your annuity.

So if you paid £50,000 and only received back £30,000 in income by the time you died, £20,000 would be paid to your beneficiary.

You can choose how much of your original purchase price you protect.

Protecting a higher amount will usually mean you get a slightly lower income. 

You can usually choose to get your income monthly, quarterly, half-yearly or annually.

The income paid by an annuity is taxed as income. The annuity provider will usually deduct tax, using your tax code, before paying the net income to you.

You might be able to get payments:

• in advance – paid at the start of the payment period, or
• in arrears – paid at the end of the payment period.

Payments can be made with or without ‘proportion’.

If you choose ‘with proportion’ when you die, a proportion of the next income payment due is paid based on the number of days since the last income payment and the date of your death.

If you’ve chosen a guarantee period and a continuing income to a dependant – and you die within the guarantee period – you can choose ‘with overlap’.

This means both the remaining income payments and the dependant’s income payments will be paid.

If you choose ‘without overlap’, the dependant’s income won’t start until the remaining income payments over the guarantee period have finished.

You might be able to combine some of these options. For example, a joint income that increases in line with inflation. Your choices affect how much income you can get.

Where you expect to live when you retire, your lifestyle such as your weight and whether you smoke, and your health at the time you set the annuity up can also affect how much income you get.

As you near your retirement age, your pension provider will send you information about the value of your pension pot and the options that are available to you to take money from your pension.

Some pension providers can offer you an income directly. However, you don’t have to take an annuity offered by your existing pension provider.

It’s important that you shop around to find the best deal for you, as you would with any other purchase. You might want to consider talking to a regulated financial adviser to help you choose the most suitable annuity.

You can use our comparison tool to search the market to help you see how much income you could get from a guaranteed income for life, or for a fixed term.

When shopping around, it’s important to watch out for pension scams.

For more information, see our guides:

Options for using your defined contribution pension pot

Understanding what Pension Wise is and how to use it

Why should I get retirement advice?