A lifetime (or pension) annuity is purchased with your pension fund, to provide a regular income for the rest of your life. Sales of annuities dropped significantly when pension freedoms were introduced in April 2015, but the certainty provided by an annuity and recent increases in the rates available mean annuities have seen renewed interest in recent years.
How do they work?
The minimum age at which you can buy a lifetime annuity is 55, increasing to age 57 from April 2028.
A lifetime annuity is purchased with the taxable proportion of your pension fund (after payment of the tax-free lump sum). There are various insurance companies that offer lifetime annuities, and you should shop around for the best annuity rate and the most suitable option.
The annuity provider then pays you a guaranteed taxable income for the rest of your life, whether you only live for a few more years or make it to your 100th birthday.
You can choose to have the income paid monthly, quarterly or annually, either in advance or in arrears. A level annuity will pay the same amount (before tax) throughout the term, while an increasing annuity will start at a lower amount but then increase on an annual basis, to provide some protection against inflation.
Your health, lifestyle and postcode are all taken into account when setting up a lifetime annuity, with even minor factors such as being slightly overweight or having been a smoker in your younger years potentially increasing the annuity rates available.
What happens when you die?
A common misconception is that an annuity will stop when you pass away. This can certainly be the case, if the annuity is set up on a single life basis, with no death benefits. However, there are several death benefit options that can be added to prevent this:
Joint life annuity – up to 100% of the annuity income would continue to be paid to your spouse, partner, or another financial dependent in the event of your death.
Value protection – A proportion (usually 100%) of the original fund used to purchase the annuity, minus any income already paid, would be returned to your beneficiaries.
Guarantee period – the annuity income can be guaranteed for any time period, for example 30 years, meaning the income will be paid either to you or your beneficiaries for at least that amount of time.
You can also use a combination of these, to ensure that your loved ones are looked after. Adding death benefits to the annuity does reduce the income payable, so it is important to compare the options.
Advantages
The main advantage of a lifetime annuity is that it provides certainty of income for the rest of your life, removing longevity risk.
They can be combined with other sources of pension income, for example part of a pension could be used to purchase a lifetime annuity while the remainder stays invested to allow flexible withdrawals.
The annuity provider takes the investment risk and guarantees the regular payments.
Disadvantages
The main disadvantage of a lifetime annuity is that it cannot be changed once it is set up, even if your health or circumstances change.
It is not possible to access additional funds from an annuity – the income is set at outset.
The income from a lifetime annuity paid on a level basis does not increase over time, meaning its real value may fall significantly due to inflation.
In summary
A lifetime annuity may be suitable for some individuals who want a guaranteed income for life, but this certainty should be weighed against the loss of flexibility.
As with all retirement products, you should only set up a lifetime annuity if you fully understand the benefits to you, as well as the costs, risks and disadvantages.
It is hugely important to shop around for the best annuity rate, and fully disclose any medical or health issues.
Once purchased, a lifetime annuity cannot usually be changed or cancelled. The income is fixed at outset and may not keep up with inflation unless an increasing option is selected.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.
This article is for information only and should not be construed as advice or a recommendation. You should always seek independent financial advice prior to taking any action.
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