Annuities - Income in retirement

Overview

When you retire you do not get access to your pension money in one go. Instead, under current rules, you can take up to 25% as a tax-free lump sum and then you are required to use the bulk of your pension fund to buy an annuity before you reach 75.

An annuity gives you an income for life. Annuities are sold by insurance and pension companies who invest the fund you give them and pay you a regular income. You can usually choose to have your income paid every month, every three months, every six months or once a year. If you have more than one pension plan or scheme, you don't have to use them all at the same time to buy an annuity, though you might be able to get a better income by combining them.

The amount - or rate - you get will depend on several things. The younger you are, the smaller the income will be as the annuity provider has to make the money last for longer. Women generally get smaller amounts too, because they live longer than men. The size of your pension fund and the value of the tax-free lump sum you take will also affect the annuity rate. You can also opt for other benefits such as arranging for your annuity to continue to pay until both you and your spouse dies or buying an annuity that starts small and increases in value each year so that you can keep up with inflation. If you smoke or have one of a range of medical conditions, you may also get a higher income by choosing what is known as an enhanced annuity. All of these factors will have an impact on the rate of your annuity.

Shop around

Because there are different options available, annuity rates can vary enormously from one company to another, sometimes by as much as 20%. For this reason, it is essential to shop around for the best annuity rather than automatically buying one from your pension provider.

The future of annuities

Annuity rates have shrunk by around a half over the last 25 years and this has led to increasing calls on the government to change the rules which make buying an annuity compulsory. As part of its pensions reform, the government has made some changes to annuity rules. From 6 April 2006, you will have the option of taking an Alternative Secured Income which could enable you to pass on any unused pension after your death. However, you will still have to take an annual income from your fund, which will then by taxed. The minimum amount will be £1 a year and the maximum will be linked to annuity rates. There will also be two new types of annuity - the Limited Period Annuity and the Value Protected Annuity. The former lasts for just five years, after which time you can buy another one, or a normal lifetime annuity. The latter will pay out any unused amount to your heirs, but you'll get a lower income than a normal annuity.