Types of annuity

In this guide: Helpful information on the various types of annuity and how to compare annuities to find the one best suited to your retirement income needs.

The main types of annuity

There is an array of annuities to choose from, each designed with specific features to accommodate various needs in retirement and later life. Almost all are a form of lifetime or fixed term annuity - the two standard types. 

1. Lifetime annuity

As the name suggests, a lifetime annuity provides an income for the rest of your life, no matter how long that might be. When you die, any money left in your pension pot will be kept by the annuity provider – you can't leave it to your beneficiaries in your Will.

You can buy one just for yourself, or on a 'joint-life' basis with your spouse or partner. A joint-life annuity is usually arranged on a ‘last survivor’ basis, so the income will continue until both people named on the policy have died.

Joint life annuity rates tend to be lower than those available with a single life annuity on the basis that the income is likely to be needed for a longer time. 

2. Fixed-term annuity

A fixed-term annuity provides an income for an agreed period of one to forty years (usually at least five or ten years). At the end of this period, you get a guaranteed lump sum payment, which is agreed when you take out the annuity. This is known as the 'maturity value'.

Your annuity provider will calculate your maturity value by deducting your annuity income from the size of your original investment.

With a fixed term annuity, you are not tied to one provider’s specific annuity rate for the rest of your life. Once the term is up you can look at what's available and choose a different annuity from a different insurer, although there’s no guarantee you’ll get the same rate or a better one.

3. Enhanced annuity

If you have poor health or a life-limiting condition, you might qualify for better benefits with an enhanced annuity.

When you apply for a standard annuity, the rates are based on average life expectancies in the UK. However, if you have a health condition which could shorten your life span, you can apply for an enhanced annuity based on a shorter life expectancy prediction. As your annuity is likely to pay out for a shorter period, you will be offered a higher rate and therefore, a greater level of income.

The older you are when you apply, the more likely you are to qualify for an enhanced annuity, so it's worth being upfront about any medical issues or ailments you have.

4. Guaranteed annuity

A guaranteed annuity ays out a guaranteed income for an agreed number of years (the guaranteed term), regardless of whether you die during that time. This allows your partner or a loved one to benefit from your pension pot after your death.

5. Level annuity

A level annuity pays out the same income for the rest of your life. This type of annuity will often offer the best rate at the outset, but be aware that the effect of inflation means the actual buying power of your income is likely to fall over time.

6. Escalating annuity

With an escalating annuity your income rises each year - either by a fixed percentage or in line with the Retail Price Index (RPI) - to protect your retirement income from the effects of inflation.

6. Variable annuity

A variable annuity allows you to allocate a portion of your pension pot to provide a guaranteed income, while the remainder is invested Any growth can be taken as extra income,  However, growth is not guaranteed, as the value of the underlying investments may fall.

7. Value protected annuity

A value protected annuity returns any money left in your pension to your estate when you die, provided you have taken less in income than the original value of your annuity. if you have taken more, no money will be paid to your estate.

8. Deferred annuity

A deferred annuity lets you delay when you start receiving your income until a later date. Between buying your annuity and taking your income - the deferred period - your money will not be taxed as income.

Why choose an annuity?

if you've been paying into a defined contribution pension scheme, one of the most popular ways to generate an income is by buying an annuity.

Your chosen annuity simply converts your pension pot (or a part of it) into a guaranteed regular income, which can be paid to you for the rest of your life or a set number of years, so you'll always know you have money coming in each month.

Under current pension rules, you can take up to 25% of your pension pot as tax-free cash to spend as you wish, when you want. You then have the choice to buy an annuity with the rest of your pension pot.

The income you receive from your annuity will be taxed as earnings.

The pros and cons of annuities

The main benefit of an annuity is peace of mind. Once you've set it up, you have the reassurance of knowing that you will get a guaranteed income throughout your retirement.

However, please be aware that once you have set up an annuity, you can't change your mind or alter it in any way, so you need to be sure it is the right route for you. You should also consider any other pension income options and whether a combination of products may be a more suitable option for you.

For more information on all the annuity options available visit the Government’s Moneyhelper website.

Try our annuity calculator

Is there an alternative to an annuity?

A popular alternative to an annuity is pension drawdown, although pension drawdown does not guarantee you an income for life. 

Instead, you withdraw money from your pension pot and remainder stays invested meaning it has the potential to continue growing in value, giving you more income. Equally, there's a risk your pension fund may fall in value. 

There's no limit to how much you can money you can take from your pension pot. You're free to:

  • Withdraw money on a regular basis
  • Withdraw a lump sum as and when you need to
  • Take your pension all in one go

It's important not to use up your pension fund too soon as you may not be left with enough to live on. However, if you're comfortable taking a level of risk and would like flexibility on how and when you can access your money, drawdown may be worth considering.

Or you may choose to mix and match ie. buying an annuity with a portion of your pension pot and investing the balance in a flexi-access pension drawdown plan

Expert guidance on retirement income and annuities

After careful consideration, we've chosen to work with award-winning retirement specialist Age Partnership to guide you through your income options and seek out the best annuity rates for you.

One of their retirement income specialists will talk you through your options in plain English, at no cost to you and with no obligation to go any further. They can look closely at a wide range of annuity providers from across the market including Aviva, Standard Life, LV, Prudential, Canada Life and Hodge Lifetime and see if you qualify for a higher income based on your health and lifestyle.

Calculate your pension income now

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