What Are Pension Annuities All About?

When researching about planning for retirement, we find that there is a lot of jargon used by financial advisers and journalists. This sometimes means that when we try to gain the knowledge we need, there has to be a specialist dictionary at hand. There is no real need for complication, so let us look at annuities.

Once you reach retirement age, you will need to transfer your pension funds (the pot of money you have accumulated over the years of your working life), into a pension annuity. This is the term used for the plan which will provide regular income throughout your latter years, ideally for the rest of your life.

The biggest concern when establishing a pension annuity, is the fact that you only have one chance to get it right. This means you must take the time and effort to choose carefully. Once you transfer your lump-sum pension monies into an annuity, you are stuck with it for life.

With so many different types of annuities available these days, it can be difficult to know which is best. So, let's look at a few, to help make your decision easier:

Standard annuity - the most conventional form of annuity. It pays a fixed income throughout the rest of your life.

Index-linked annuity - this provides a lower income now, but with amount rising over the future years, in line with the chosen index.

Profits annuity - pays in accordance to the profits made on your initial investment, so should be expected to provide a rising income.

Unit-linked annuity - perhaps the riskiest of the annuity plans, it is subject to fluctuations in investments made.

Impaired life annuity - this is a type of annuity designed for those whose state of health means that their life expectancy is lower than someone of the same age in the general population. It should provide a higher level of income, to reflect the fact that it may not have to be paid for as long as average.

When you make the decision about the type of annuity, it is worth considering the effects of inflation; everyone know that prices rise over the years, so a level income will not provide the same standard of living in say 20 years, as it does now. To allow for this, it might be sensible to go for the index-linked option, which provides a lower income now, but with amount rising over the future years.

Should you be in the position of having cash which has not been built up by investing in a pension scheme - from an inheritance, or sale of a property for instance, then you could turn this cash lump sum into a life-long income by purchasing an annuity. These are usually available from the same investment and insurance companies which offer pension schemes.

This idea could also be used if you have a need for a higher income, rather than an immediate cash lump sum. The tax-free lump sum available at retirement, could be used to purchase an annuity. When there is an alternative offered of higher pension or tax-free lump sum, then opting for the lump sum could be a good idea anyway, because in some cases, the tax on the income from a 'purchased life annuity' may be less than the tax on the pension income itself. This is because a part of the income from the purchased annuity is treated as return of your own capital, hence not subject to income tax.

While this is by no means a full explanation, I hope it has made some of the ideas discussed less mysterious. When looking at our finances, it is probably impossible to have too much knowledge. The time spent researching and getting it right will make a big difference in the long term.