About annuities

An annuity pays you a guaranteed income for life. It is a policy that converts a lump sum (normally your pension pot) into a series of regular income payments for the rest of your life no matter how long you live.

Annuities are provided by insurance companies who invest your money in secure assets and will pay you a regular income every month (other frequencies are available) for the rest of your life. If you select a joint annuity, and you die before your spouse or partner, the income will continue for the rest of their life.

The amount of annuity income depends on a number of factors including:

Your age and health – the older you are the higher the annuity payments and if you have certain health conditions you may qualify for a higher (enhanced) annuity
Interest rates – annuities are priced with reference to bond yields (fixed interest investments) so when yields are low annuity rates are low and vice versa
The annuity options – e.g. single or joint life, level or increasing, income guarantee period or value protection and choice of payment terms.

Enhanced Annuity - You can get a higher annuity income if you smoke, are taking prescription medication or have recently had medical treatment for a condition.

More about annuities

Most annuities pay a guaranteed income for life and have the following characteristics:

They pay an income for the rest of your life (and your partner's life if joint life), no matter how long that is
They are based on the principle of ‘mortality cross subsidy’
Enhanced rates are available for those in poor health
On death, payments stop unless a joint life annuity, a guaranteed payment period or value protection option has been selected
Payments can remain level or increase each year

In order to meet the income for life promise, annuities are based on the concept of mortality cross subsidy.

Mortality cross subsidy is unique to annuities and clearly favours those in good health who may live longer than expected at the expense of those who die early. To overcome this problem some insurance companies provided enhanced annuities. Enhanced annuities pay a higher income for those who have a medical condition that may reduce their normal life expectancy.

An annuity converts your pension pot into a series of regular income payments

Case for annuities

The case for annuities can be made very simply; they are the only policy that can pay a high level of guaranteed income for life. In this sense an annuity is a pension, and in the rush to give people more choice it is easy to lose sight of why people save for a pension in the first place.

A more sophisticated case can be made because annuities meet the needs and objectives of people who want to make sure that they will have a regular income for the rest of their life with the peace of mind and security that they will never run out of income.

Annuity Options

A basic annuity will stop making payments when the policyholder dies. In order to protect against the risk of losing out if the annuitant dies before getting a good return on the investment, or losing out to inflation, annuities have a number of options. These include:

Joint life
Guaranteed payment periods and Value Protection
Escalation

Enhanced Annuity

An enhanced or impaired life annuity pays a higher income because an allowance is made for any medical conditions which might reduce life expectancy

You will probably qualify for an enhanced annuity if you can answer yes to one of the following questions:

Do you smoke?
Are you taking prescription medication?
Have you been to hospital recently for a medical condition?

Mortality Cross Subsidy

Insurance companies make a profit from those dying early and a loss from those living longer, and they use the profits from the early deaths to subsidise the income paid to those who live longer than expected - This is mortality cross subsidy.

Fixed Term Annuity

Also known as ‘fixed term annuities’ these are plans which pay a guaranteed income for a specific period of time and at the end of the term there is a guaranteed amount paid pack into the plan.

Fixed term income plans are a type of drawdown plan which means that income payments are paid directly from the pension fund and the amount of the fund left over after making these payments is paid back to your pension plan