How Do Pension Annuities Work?

You may want to consider starting a pension now, so you can live comfortably in later life. Prestige Tax and Trust Services asks: how do pension annuities work?

Retirement income

Experts believe that when planning retirement income, you should aim to receive £15,000 – £20,000 per annum to live comfortably and have disposable income in later life. You may find that the state pension, along with any workplace pension schemes you are enrolled into, do not provide you with enough income to meet this goal. In this case you should consider signing up to personal pension.

Explaining annuities

After you retire, you can withdraw money from your pension pot in a number of ways. Many people buy an annuity, which was legally required until 2015, supplied by their pension provider or an insurance company. An annuity is an insurance contract where in exchange for giving the provider your pension pot as a lump sum, you receive regular income. The types of annuity are:

  • Temporary annuity: You receive guaranteed regular income for a fixed number of years.
  • Lifetime annuity: You receive guaranteed regular income for the rest of your life.
  • Enhanced annuity: A lifetime annuity based on life expectancy, meaning that you may receive a higher payment rate if you meet certain conditions which could shorten your life.
  • Postcode annuity: A lifetime annuity, based on where you live. If you live in a wealthy area, for example, you may live longer due to better conditions, resulting in a lower rate.
  • Impaired life annuity: A lifetime annuity, for those who suffer from medical conditions. Your medical information is used to calculate your life expectancy, determining your rate.
  • Investment-linked annuities: A lifetime annuity, where part of your earnings are guaranteed and part are linked to investment, so you would receive more when markets are doing well.
  • Purchased-life annuities: A temporary or lifetime annuity, which you purchase with money other than your pension. These are taxed slightly differently to other annuities.

Annuity payments

Your provider will use various factors to determine how much you are paid via annuity contract. This includes whether it is temporary or lifetime, your age at the start of the annuity, the amount you have available to buy the vehicle (purchasing price), interest rates/anticipated future investment returns and lifestyle factors e.g. state of your health. The firm may also deduct tax, using your tax code, from the annuity’s net income, as said income is taxed as normal earnings by HM Revenue and Customs.

Pension options

You can also select options in your annuity contract, to determine how you receive your funds. Some options, such as taking some of your pension pot as a tax-free lump sum, can reduce the starting amount of your annuity, limiting your regular income. Others, such as escalation annuities, where your payments increase each year to counter the effects of inflation, can raise your revenue. You should check out the Pension Advisory Service’s annuities guide for a full explanation of the options available.

Shop around

You should keep in mind that there are various types of annuities and some may be more suitable than others. We would advise you to refrain from taking the annuity policy supplied by your pension provider, without researching your options first. You may want to use price comparison services, such as Money Wise or consult an Independent Financial Advisor, to ensure you get real value for money.

Prestige Tax and Trust Services

Whether you buy an annuity or not, ensure that you have enough money to both live comfortably in later life and fund the cost of care, should it become necessary. It is wise to enlist expert aid, when dealing with cost of care matters, as they can be complex. As experts in this field, Prestige Tax and Trust Services can help you deal with the cost of care, so you can be financially secure in retirement.

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