How Annuities Work

An annuity is, at its most simple the exchange of a guaranteed income in return for a lump sum. Therefore a lifetime annuity will continue to pay irrespective of how long the holder (the annuitant) lives.

The amount of income an annuity will pay depends on:

• the amount that you have in your pension fund

• your age, sex and your health at outset

• the benefit options that you choose; for example, do you want to provide an income for your partner after your death?

March 2009 - June 2010

Monthly gross payments for a male, 65, non-smoker, single life annuity, 10 year guarantee. Purchase price £120,000

The amount of income an annuity provides each year in return for the lump sum from your pension fund is called the 'annuity rate'. Annuity rates are usually quoted for a man or woman of a given age. You may see an annuity rate expressed as a percentage. For example, an annuity rate of 6% is the same as £600 a year income for every £10,000 invested. Annuity rates change frequently, so do shop around for the best deal as you near retirement.

Usually, the starting income from the same size of pension fund is higher for a man than for a woman, assuming they are the same age. This is because, on average, men do not live as long as women.

The income that you get at the start of an annuity is higher the older you are. You can usually choose for your income to be paid every month, every three months, every six months or once a year. This can be paid in advance or in arrears. There could be a tax advantage by choosing a payment in arrears depending on your tax position in the year of retirement.

There are different annuities to suit different needs. The main types are:-

• Level

• Escalating

• Investment Linked

• Value Protected