Using your pension pot to buy a lifetime annuity

A lifetime annuity is a type of retirement income product that you buy with some or all of your pension pot. It guarantees a regular retirement income for life. Lifetime annuity options and features vary – what is suitable for you will depend on your personal circumstances, your life expectancy and your attitude to risk.

How a lifetime annuity works

You choose to take up to 25% (a quarter) of your pension pot – or of the amount you are allocating to buy an annuity – as a tax-free lump sum. You then use the rest to buy an annuity, which will provide you with a regular income for life.

This retirement income is taxed as normal income. As a rule of thumb, the older you are when you take out an annuity, the higher the income (annuity rate) you’ll get.

There are two types of lifetime annuity to choose from:

  • Basic lifetime annuities – where you set your income in advance
  • Investment-linked annuities – where your income rises and falls in line with investment performance, but will never fall below a guaranteed minimum

Basic lifetime annuities

Basic lifetime annuities offer a range of income options designed to match different personal circumstances and attitude to risk. You need to decide whether you want:

  • One that provides an income for life for you only – a single life annuity, or one that also provides an income for life for a dependant or other nominated beneficiary after you die – called a joint life annuity
  • Payments to continue to a nominated beneficiary for a set number of years (for example 10 years) from the time the annuity starts in case you die unexpectedly early – called a guarantee period
  • ‘Value protection’ – less commonly used, but designed to pay your nominated beneficiary the value of the pot used to buy the annuity less income already paid out when you die

Your choices affect how much income you can get.

Where you expect to live when you retire may also affect how much income you get.

Find out more about single or joint life annuities

Find out more about fixed or increasing income annuities

Find out more about guarantee periods and value protection

Higher income for medical conditions or unhealthy lifestyle

If you have a medical condition, are overweight or smoke, you may be able to get a higher income by opting for an ‘enhanced’ or ‘impaired life’ annuity. Not all providers offer these so be sure to shop around if you think you might benefit from one.

Find out more about enhanced and impaired life annuities in our guide Higher income for people with poor health.

For a quick overview of basic lifetime annuities, watch our video What is an annuity?

To find out which basic lifetime annuity features and options might be right for you, and how much retirement income you might get in the current market, use the Money Advice Service annuity comparison tables. However get guidance or advice before you commit – remember, a lifetime annuity is just one of several options you have for taking a retirement income.

Investment-linked annuities

Investment-linked annuities also pay you an income for life, but the amount you get can fluctuates depending on how well the underlying investments perform. If the investments do well, they offer the chance of a higher income. But you have to be comfortable with the risk that your income could fall if the investments don’t do as well as expected.

All investment-linked annuities guarantee a minimum income if the fund’s performance is weak.

With investment-linked annuities you can also opt for joint or single annuity, guarantee periods, value protection and higher rates if you have a short life expectancy due to poor health or lifestyle. Not all providers will offer these options – you’ll need to shop around then get financial advice.

Find out more about investment-linked annuities

Things to think about

Once you buy an annuity you can’t change your mind, so it’s important you get help and advice before committing to one. See our guide Retirement – why should I get advice?

If your provider offers you a basic annuity with a ‘guaranteed annuity rate’ this will be hard to match in the market – however shop around to check. Then get help and advice. See the later section on shopping around.

If you have a very limited life expectancy, an annuity may not be the right option for you.

Think carefully about whether you need to provide an income for your partner or another dependant after you die.

What happens when you die?

If you have a single annuity and no other features, your pension stops when you die. Otherwise, the tax rules vary depending on your age as shown below.

If you die before age 75

  • Income from a joint annuity will be paid to your dependant or other nominated beneficiary tax-free for the rest of their life
  • If you die within a guarantee period the remaining annuity payments will pass tax-free to your nominated beneficiary then stop when the guarantee period ends
  • Any lump sum payment due from a value protected annuity will be paid tax-free

If you die age 75 or over

  • Income from a joint annuity or a continuing guarantee period will be taxable at the beneficiary’s highest tax rate
  • Joint annuity payments will stop when your dependant or other beneficiary dies
  • Any guarantee period payments stop when the guarantee period ends
  • Any lump sum due from a value protected annuity will be taxable at 45% if paid before 6 April 2016 and at the beneficiary’s highest tax rate if paid after that date

Shopping around for an annuity

Research by the Financial Conduct Authority showed that 8 out of 10 people could get a better annuity income by shopping around rather than buying from their own provider. (Source: Thematic review of annuities, February 2014, Financial Conduct Authority)

If you decide an annuity is right for you it’s important to shop around. Research by the Financial Conduct Authority showed that most people could get a better annuity income by shopping around rather than buying from their own provider.

For practical tips on shopping around for a basic lifetime annuity read our guide How to shop around for an annuity.

If considering an investment-linked annuity we recommend you speak to a financial adviser.

You can find FCA registered financial advisers who specialise in retirement planning in our Retirement adviser directoryopens in new window.

Your other retirement income options

A lifetime annuity is just one of several options you have for using your pension pot to provide a retirement income. For an overview of all of your options and more on where to get help and advice see our guide Options for using your pension pot.

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