Key considerations before buying an annuity

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Buying an annuity can provide you with a regular, guaranteed income during retirement. However, the choices you make before buying one can affect how much income you receive, how long it lasts and what happens to your money when you die.

In this guide, we explain what to consider before buying an annuity, from choosing the right type of income to comparing providers and checking whether your health could help you qualify for a higher rate.

What should you consider before buying an annuity?

Before buying an annuity, there are a few key decisions that can affect how much income you receive and how well it suits your retirement plans.

• Work out how much guaranteed income you need.
  Consider how much of your essential spending you want to cover and whether you need to use all or only part of your pension to provide that income.
  
• Choose how you want your annuity income to work.
  Decide whether you want income for life or for a fixed term, and whether payments should stay level or increase over time. 
  
• Consider whether you need to protect someone else.
  If a partner or dependant relies on your income, joint-life options or other death benefits may help provide financial support after you die. 
  
• Check how your circumstances could affect your annuity rate.
  Your age, health and lifestyle can influence the income available, while comparing providers may help you find a more suitable rate or set of features.
  

An annuity converts some or all of a pension pot into a guaranteed retirement income. Depending on the product you choose, this income may last for the rest of your life or for an agreed number of years.

The following questions can help you understand which features may be suitable for your retirement plans.

1. Do you want guaranteed or flexible retirement income?

An annuity may appeal to you if you want certainty over the income you will receive. Once established, a lifetime annuity normally continues paying an income for as long as you live, regardless of how long that is.

However, this certainty usually comes at the expense of flexibility. Once most lifetime annuities have been set up, they cannot usually be changed, transferred or cashed in.

Before buying one, consider:

• How much of your essential spending needs to be covered by guaranteed income.
  
• Whether you already receive secure income from the State Pension, a defined benefit pension or another annuity.
  
• Whether you may need access to larger sums later in retirement.
  
• Whether you are comfortable leaving some of your pension invested.
  
• Whether providing an income or lump sum for someone after your death is important.

An annuity is not the only way to access a defined contribution pension. With pension drawdown, your money generally remains invested, and you can choose when and how much to withdraw. This offers greater flexibility, but your pension remains exposed to investment movements and your income is not usually guaranteed for life.

You may not have to choose one option exclusively. Some people use part of their pension to buy guaranteed income while leaving the remainder invested. Our guide to annuities versus drawdown explains the main differences.

2. Do you want to use all of your pension or some of your pension?

You do not necessarily have to use your entire pension pot to buy an annuity. You may be able to use part of it to cover essential spending while keeping the rest available through another retirement option.

Start by reviewing the secure income you already expect to receive and compare it with your likely expenditure. This can help you identify any gap that an annuity may need to fill.

For example, you might use an annuity to cover regular essentials such as housing costs, utilities and food. Other pension savings could then remain available for discretionary spending, emergencies or future care needs.

You should also consider whether to take any tax-free cash from your pension before purchasing an annuity. You can normally take up to 25% of a pension pot tax-free, subject to the applicable lump sum allowances. However, doing so leaves less money available to buy an annuity and will usually reduce your regular income.

3. Do you need a lifetime or fixed-term annuity?

Another key consideration is how long you want the guaranteed income to last.

Lifetime annuity

A lifetime annuity provides a guaranteed income for the rest of your life. It can be suitable if your main priority is knowing that the income will not run out, regardless of how long you live.

The terms are generally set when the annuity is purchased, so it’s important to choose the payment and death-benefit options carefully.

Fixed-term annuity

A fixed-term annuity provides guaranteed income for an agreed period rather than for the rest of your life.

At the end of the term, you may receive a pre-agreed maturity amount, depending on the product and options selected. You can then review your circumstances and decide what to do next, such as buying another annuity or considering a drawdown.

4. Should your annuity income stay stable or increase over time?

You will need to choose whether your annuity income remains level or increases over time.

A level annuity pays the same amount throughout its term. It will generally provide a higher initial income than an equivalent increasing annuity, but inflation may gradually reduce what that income can buy.

An increasing or escalating annuity starts with a lower income but increases over time. The increase might be a fixed percentage each year or linked to a measure of inflation, depending on the provider and product.

You should consider how your spending could change throughout retirement. Some costs may decrease, while expenses relating to household support, health or care could rise.

Do you need to provide an income for someone else?

A single-life annuity normally stops when you die unless you have selected another form of death benefit.

A joint annuity can continue paying an income to an eligible spouse, partner or dependant after your death. You will usually choose what percentage of your income continues, such as 50%, 66% or 100%, subject to the provider’s available options.

Adding joint-life protection will generally reduce the income you receive at the beginning. Before deciding, consider:

• Whether your partner relies on your retirement income.
  
• What pension income they would receive in their own right.
  
• Their age and health.
  
• Your shared household costs.
  
• The proportion of your income they would need after your death.

The right choice will depend on your wider household finances rather than simply which option provides the highest starting income.

5. What should happen to your annuity when you die?

Annuity death benefits can provide some protection for the people you leave behind. The available features may include joint-life income, a guarantee period, and value protection.

Guarantee period

A guarantee period means payments will continue for a minimum number of years, even if you die during that period.

For example, if you select a ten-year guarantee period and die after four years, payments may continue to your beneficiary or estate for the remaining six years, depending on the terms.

Value protection

Value protection may return some of the original amount used to buy the annuity, minus the income already paid. The exact calculation and tax treatment depend on the product, your age when you die and the applicable pension tax rules.

Joint-life income

A joint-life annuity can continue paying an agreed proportion of your income to an eligible person after your death.

These benefits provide additional protection but will normally reduce your starting income. You can explore more on the available options in our frequently asked questions on protecting your annuity.

6. When should you buy an annuity?

There is no single best age or market condition for buying an annuity.

The annuity rate you are offered can be affected by your age, health, the size of your pension, the features selected and wider economic conditions. Once a lifetime annuity has been purchased, its rate will normally remain fixed under the terms selected.

Waiting until later in life may result in a higher annual income because the provider expects to make payments for a shorter period. However, you will also need another way to fund your retirement while you wait.

Delaying may also leave your pension exposed to investment movements if it remains invested. Annuity rates can rise or fall during this period, so waiting does not guarantee a better overall outcome.

Some people buy annuities in stages rather than converting their entire pension at once. Others consider a fixed-term annuity if they want temporary certainty before making a longer-term decision.

Questions to ask before choosing an annuity

The right annuity will depend on what you want from your retirement income. Before choosing one, it can help to think about questions such as:

• How long do I want my annuity income to last?
  You can choose an income that lasts for the rest of your life or, with a fixed-term annuity, for an agreed number of years. 
  
• Do I want my annuity income to increase over time?
  A level annuity usually pays the same amount, while an increasing annuity can provide payments that rise over time. 
• Does anyone else rely on my retirement income?
  If a partner or dependant relies on your income, you may want to consider an annuity that can continue paying them after you die.
• What would I like to happen to my annuity when I die?
  Depending on the options you choose, you may be able to include features such as a guarantee period, joint-life income or value protection.
• Could my health affect the income I receive?
  Certain health conditions and lifestyle factors may qualify you for an enhanced annuity, which could provide a higher income.

Explore your annuity options with LV=

Choosing an annuity is a significant retirement decision. The income, death benefits and other features you select can affect your finances for many years, so it can help to talk through the options available before making a decision.

If you’re considering an annuity, you can request a call back to discuss your circumstances, the income you’re looking for and the options available to you.

We can search rates for lifetime and fixed-term annuities from across the whole of the market. You can also explore your annuity options to learn more about the different types of guaranteed retirement income available.

Need more information? Our pensions and retirement guides have lots of useful information to help with planning for your retirement.

Further annuity FAQs

Buying an annuity can involve several long-term decisions. These FAQs cover some of the most common questions about timing, flexibility and how much of your pension to use.

Can I change my annuity after I have bought it?

Most lifetime annuities cannot usually be changed, transferred or cashed in once they have been established. Check the income, payment and death-benefit options carefully before completing the purchase.

Should I use my whole pension to buy an annuity?

Not necessarily. You may be able to use only part of your pension to buy guaranteed income and leave the remainder invested or available through another retirement option. Consider how much guaranteed income you need and whether you may need access to savings later.

Should I take tax-free cash before buying an annuity?

You can normally take up to 25% of your pension as tax-free cash, subject to the applicable allowances. However, this leaves less money available to buy the annuity and will generally reduce the income you receive.

Is it better to buy an annuity when rates are high?

Higher annuity rates can provide more income from the same pension pot, but predicting future rates is difficult. Your age, health, retirement needs and the features included in the annuity are also important considerations.

What is the best age to buy an annuity?

There is no single best age. Buying later may result in a higher annual income, but you will need another way to fund your retirement in the meantime. Your health, pension value and wider plans should also form part of the decision.

Can I buy more than one annuity?

Yes. You may be able to use different parts of your pension to buy annuities at different times. This can allow you to secure additional guaranteed income as your retirement needs change, although each purchase should be considered alongside your overall plans.

Do I need financial advice before buying an annuity?

Financial advice is not always compulsory, but it can help you compare complicated or permanent retirement choices. An adviser can assess the options alongside your income needs, tax position, dependants and other pensions.

Can I buy an annuity from a different pension provider?

Yes. You do not normally have to accept the annuity offered by your current pension provider. Shopping around may help you find a different rate, enhanced terms or features that better suit your circumstances.