Overview
An annuity is simply a series of payments made at selected intervals in return for a pension fund.
The level of payment is dependent upon age, annuity rate, size of fund and options selected. Annuity rates tend to mirror interest rates since they are related to the returns earned on Fixed Interest Gilt Edged Securities.
There are many different types of annuity and these are covered later on in this section.
Tax Free Cash
Most types of pension plan have the option of taking a tax-free cash lump sum before exchanging the residual fund for a series of payments.
Once an annuity has been purchased there is no further entitlement to tax-free cash, therefore the decision of whether to access the cash or not needs to be made at outset.
Income
Annuity payments are taxed at source under the PAYE system. Provided a P45 is presented the annuity will be paid net of your marginal rate of tax and there will be no further tax liability.
Payments can be made monthly, quarterly, half yearly or yearly and can be in advance or arrears. Payments can remain level, can decrease or can increase e.g. at a set rate or in line with an index such as the Retail Prices Index.
Death Benefits
The option of what type of death benefits to include must be made at outset.
The options available are as follows:-
- A spouse’s or dependents pension up to 100% of the pension you had received
- A lump sum
Protecting your annuity
There are ways of protecting your annuity if you're worried about what will happen to it if you die soon after you retire.
Commonly known as Value Protection, this option can be included to ensure that on death), the original fund value, less the gross income payments already made, can be paid out. On death before age 75, this will be tax free. On death after age 75, this is taxed at the beneficiaries’ marginal rate of income tax.
Guarantee periods allow you to opt for your annuity to pay out for a specific number of years even if you die within this time. On your death the income may continue to be paid for the rest of the guarantee period. You should not look at a guarantee as an alternative to a joint-life annuity, because any income will stop at the end of the guarantee period, not when your spouse or partner dies.
You should note that where the value of the annuity on death is below £30,000 it may be possible for the remaining guaranteed payments to be paid as a lump sum.
Advantages
You will receive a guaranteed income for life, and you can elect for your spouse/beneficiaries to receive a guaranteed income or a lump sum less tax upon your death.
Tax-free cash is available at outset.
There are no additional charges applied to the contract once in force. All charges are taken at outset and are reflected in the annuity rate offered.
The contract is simple to understand, there is no need to review the contract and there is minimal paperwork needed to start the payment of benefits.
Disadvantages
There is no opportunity of participating in future investment returns.
The various options in relation to death benefits and increasing / decreasing income levels etc must be selected at outset and will result in a lower initial pension payment. These selected benefits cannot be altered in the future.
Suitability
Lifetime annuities are most likely to suit individuals who want an absolute guarantee on their pension payments and/or for their spouse/partner. They therefore suit individuals with low attitudes to risk and a requirement for security. They also suit individuals who have relatively small pension funds and who will be heavily reliant on their pension income.
