What is an Annuity? 

An annuity is a lump sum investment product sold by insurance companies. It is a way of converting capital, often from a pension fund built up during your working life, into an income for the rest of your life or, in certain instances, for the life of your partner too.  

An annuity is the most common method of obtaining an income from a pension. After taking any tax-free lump sum, you use the whole of the remaining fund to purchase an annuity. The annuity pays an income for the rest of your life. It's possible to convert only part of your pension to an annuity and delay converting the rest until a later date - you may wish to do this if you move from full to part time work as you approach retirement.  

Unlike other investments, it cannot be exhausted however long you may live. 

This is quite complex, but a number of factors have combined to bring this situation about.

We are all living longer. A few years ago an annuity taken out by a 65 year old man at retirement may have only been paid for 5 years before he died. Now, his life expectancy is probably 15 years more than it was then.

Interest rates and inflation rates have fallen. These affect gilt rates with which annuity income is backed. A 10% annuity was quite feasible when interest rates were 8% and inflation 7%, but this is not the case now. If you wait, the situation could change – for better or worse!
 

There is an element of “cross subsidy” with annuities. In short, those who die young benefit those who survive. With the advent of Unsecured Pension, this subsidy is likely to decrease as fewer people buy annuities. Unsecured Pension is not available to or suitable for everyone, so an annuity may still be your best choice.

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.