The difference between a pension and an annuity
In short, and as a generalism, a pension is the money you save to provide an income in later life. An annuity is a financial product you can buy with that pension ‘pot’ of money, to guarantee you’ll get the income for as long as you live. Easy. OK, so why are the two terms pension and annuity so often confused? Here’s the problem: the government also uses the word ‘pension’ to describe the money it will pay you, if you qualify, for the rest of your life.
The government lets you claim a State Pension when you reach the State Pension Age. It’s a sum of money you’ll receive, typically after you retire from being employed. In addition to any State Pension though, you may have a private pension, or a company pension – a pot of money that’s (hopefully) been invested carefully on your behalf, while you’ve been working.
Hopefully you’ll make sensible decisions over what to do with it, to supplement any State Pension as you get older. The rules on what you can do with you pension pot are changing, quite dramatically, but just one of the many things you can still do is buy an annuity.
An annuity is a type of insurance policy. You hand over a pension pot (or part of it) to an annuity provider, and that company will give you an income for the rest of your life. In essence, the company uses what it knows about you to estimate how long you’ll live, and then works out how much it will pay you, every month, in exchange for your pension pot.
Your pension provider will offer you an annuity, it’s part of what they do. But – much like car insurance – it can pay to shop around.