In our guide that details what is annuity you’ll learn about the importance of saving for your retirement and find out exactly what happens to all of that money that accumulates in a pension. Your pension pot is your life preserver after retirement. It’s what you’ll live off of once you decide to finally hang up your hat, kick back, and relax, during your golden years.
Now, let’s learn more about annuities, what they are, and how they work.
The government doesn’t want you to be able to touch your pension pot whenever you feel like it. Your pot provides tax relief each time you make a contribution, thus it wants to get some taxes back.
Currently, buying a lifetime annuity is the most popular way of taking your pension money. So, what is an annuity, exactly?
By handing over a large lump sum of your pension pot, an insurance company will give you an annual income for the rest of your life. Essentially, annuities are insurance contracts.
If you live for decades and are able to take advantage of this annual income, then an annuity is a great option. However, if you die in an accident, you’ll lose a large portion of your pension pot.
In the past, the government set in place a rule that only made those under the age of seventy-five eligible for annuities. Fortunately, that rule has since been abolished. Additionally, there are also more options regarding taking your money during retirement. Now, annuities are not the only way to do this.
However, most people have found annuities to be the best option because it can be purchased when you begin your retirement, regardless of how old you are. Essentially, the sooner you retire, the longer your money will last. Unfortunately, this also means the annual income you receive will also be much lower.
The amount of annual income an annuity provider offers you will depend on several factors, including the following:
- Since men do not live as long as women, men tend to get a higher annual income
- The younger you are, the lower your annual income
- Lifestyle and current health status can also affect your income. People who live unhealthy lifestyles, such as those who smoke will often get a higher annual income since they aren’t expected to live as long as a nonsmoker.
Aside from these personal factors, there are several external influences that can also impact your annuity rates.
When you hand over a larger portion of your pension pot to an annuity provider, the provider will invest the money to ensure there’s enough money to continue to pay the annual income of the retiree.
Instead of gambling with your pension pot funds on the stock market, the annuity provider will invest the money in gilts. Gilts are short-term loans to the government. The government, of course, will pay interest. The interest rates that are paid by the government have fallen over the past several years as the demand for these short-term loans has skyrocketed. This means lower returns from gilts equals lower income rates.
Picking the right type of annuity is crucial since you can’t change your mind once you sign up.
There are several annuity options to choose from:
- Escalating annuities
- Level annuities
- Single life annuities
- Joint life annuities
- Enhanced annuities
- Guaranteed annuities
- Value protected annuities
- Fixed-term annuities
With an annuity, the insurer will get to keep any funds left when you die. However, if you choose a value protected annuity or a joint life annuity, your partner, spouse, or anyone you’ve nominated can receive the money, as long as you die before the age of seventy-five. If you’re over the age of seventy-five when you die, then the payments will be taxed.
To learn more about annuity options, click here to read our article on types of annuity.
Is an Annuity the Best Option?
If you’re looking for a better investment option, an ISA may be a better choice. These individual savings accounts allow the holder to invest or save money without paying tax on the interest. You can click here to learn more about ISAs in our extensive guide.
However, if you need viable income now, then an annuity may be the best option available.
You should choose an annuity if you’re on a fixed income and need an income that’s guaranteed for the rest of your life, or you don’t want your income to be vulnerable to fluctuations in the stock market.
Additionally, annuities can be the best choice if you want your income to increase with inflation, or you have a serious health condition and can qualify for a higher annual income from an annuity.
If you’ve been diagnosed with a terminal illness, then an annuity is not the way to go. You should also avoid signing up for an annuity if you prefer to keep your money invested, or you prefer a single annuity but want to leave something behind for your family or partner.