Annuities: How They Work and Who They Suit
An annuity exchanges a lump sum for a guaranteed income, usually for life. The insurer takes on longevity risk, meaning the income continues however long you live.
The decision is generally irreversible once made, which is why it deserves careful thought rather than being taken by default.
What determines the rate
Age at purchase is the largest factor. Older purchasers receive higher rates because the expected payment period is shorter.
Interest rates in the wider economy affect annuity pricing substantially, which is why rates available vary considerably over time.
Health and lifestyle matter, and this is the most commonly missed opportunity. Enhanced or impaired-life annuities pay more to people with conditions reducing life expectancy — including common ones such as high blood pressure, diabetes, smoking history and being overweight.
A substantial proportion of purchasers qualify for an enhanced rate and never disclose the information that would secure it, because they were not asked properly.
The options that reduce the headline rate
A joint-life annuity continues paying a proportion to a surviving spouse. It reduces the starting income and protects the survivor, and for couples it is frequently the appropriate choice.
Inflation-linked or escalating annuities start considerably lower and rise over time. The starting income is markedly lower, and over a long retirement the protection matters.
A guarantee period pays for a minimum number of years regardless of death, protecting against the outcome of dying shortly after purchase.
Value protection returns a portion of the original capital on death.
Each of these costs income. The choice is between a higher income now and protection against specific risks.
Who they suit
People who need certainty that essential spending is covered for life, regardless of markets or longevity.
People without other guaranteed income beyond a state pension.
People uncomfortable with investment risk or who do not want to manage drawdown decisions into later life, when the capacity to do so may reduce.
Who they suit less
People with substantial guaranteed income already covering essentials.
People wanting to leave capital to beneficiaries, since a basic annuity generally leaves nothing.
People with significantly reduced life expectancy, unless an enhanced rate reflects it adequately.
Practical points
Shop the open market rather than accepting the provider's default offer. Rates vary between providers, and the difference over a lifetime is substantial.
Disclose all health and lifestyle information fully when obtaining quotes.
Consider annuitising part of the pot to cover essential spending while keeping the remainder invested for flexibility, which is a common and sensible middle position.
This article is general information and not financial advice. Consider regulated advice before making an irreversible decision.
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