Types of annuities explained

There are a few types of annuity, and each one works a little differently. They are not all one size fits all. Understanding the different types could make it easier to spot the options that match your long-term financial plans and goals.

For example, you can choose an income that stays the same (level) or one that rises each year to help your money go further. You can also check whether health or lifestyle details could mean a higher income with an enhanced annuity (more on this below). And if supporting those you care about is a top priority, then you could explore add-ons like value protection or a guarantee period (more on this below).

Pension annuity

A pension annuity provides a regular, guaranteed income for the rest of your life, using money from your pension pot. This can make it easier to plan your retirement finances, knowing you’ll have a dependable income for life.

You can choose an annuity that increases over time to help protect your income from rising costs, although this will usually provide a lower income at first. Alternatively, a level annuity pays the same amount throughout your life.

You may qualify for a higher income if certain health conditions or lifestyle factors could affect your life expectancy. You can also choose options that provide financial support for your loved ones after you die, including:

• a guaranteed period – if you die within a set number of years, payments will continue until the end of that period.
• value protection – this may provide your loved ones with a lump sum if the total income you’ve received is less than the amount used to buy your annuity.

Rates and options vary between annuity providers, so it’s important to shop around. This can help you find an annuity that suits your needs and may provide a higher income. Once your annuity is set up, you usually can’t change it or cash it in.

Enhanced annuity 

Some annuities offer enhanced rates based on information about your health and lifestyle. These annuities may often pay a higher regular income if certain medical conditions or lifestyle factors are likely to reduce life expectancy. Behind the scenes, annuity pricing is linked to life expectancy. If a provider expects to pay an income for a shorter period, this could be reflected in the price of the annuity. This may mean either a lower cost for the same income or a higher income for the same pension savings.

It’s worth checking whether you qualify, as you could receive a higher income. It’s also important to explore options from different annuity providers and consider getting financial advice before making any decisions. 

Fixed term annuity (also known as a fixed term income plan)

A fixed-term annuity uses money from your pension savings to provide a regular income for a set period that you choose. You may also be able to include a guaranteed lump sum, payable at the end of the term.

A fixed-term annuity may be classed as a short-term annuity if it’s provided by an insurance company, bought using some or all of the money in a drawdown fund, and lasts no longer than five years.

This type of annuity could be right for you if:

• you want a guaranteed income for a set period.
• you’re not ready to commit to a lifetime annuity
• and you want to keep your retirement options open.

Once your plan starts, it can’t usually be changed. In some cases, you may be able to exit early and cash it in, but this isn’t guaranteed and may involve charges or a reduced value.

Immediate life annuity

An immediate life annuity, also known as a purchased life annuity, provides a guaranteed income for the rest of your life. If you’re buying the annuity yourself, you’ll need at least £7,500 once adviser charges have been deducted. If someone is buying it on your behalf, such as the trustees of a will, they’ll need at least £100,000 after adviser charges. It’s bought using money from your own savings, an inheritance or tax-free cash from a maturing pension.

It can be a tax-efficient way to add to your retirement income using money held outside a pension pot. Each payment is usually made up of two parts: 

• a capital element, which is treated as a return of some of your original investment and can be paid tax-free.
• an interest element, which is taxable as savings income. This means you may not pay tax on the full amount of each payment.

Your income will normally stop when you die, unless you choose a death benefit. For example, you may be able to pass an income or lump sum to your spouse or other family members.

Lifetime Care 

A lifetime care annuity, also known as an "immediate needs annuity" works as a financial cushion in case an illness, condition or disability leaves you needing long-term care later in life.

It's usually bought using your own funds, like savings or money from the sale of a home. In return, it pays a regular income that can cover some or all of the care costs for the rest of your life.

Payments are normally made directly to a registered care provider or local authority to help pay for care. When certain conditions are met, these payments are not subject to income tax.

This type of annuity is a type of purchased life annuity and is sometimes described as long-term care insurance. It can help you feel more reassured by turning potentially large, uncertain care costs into a regular, predictable payment, so you and your family can plan ahead with more confidence.