With so many retirement options available, how do you know what’s going to be right for you?
We’ve put together some information to help you understand how one type of product – an annuity – works and when it can be a good option.
What is an annuity?
An annuity is a retirement product that pays you a regular income – usually monthly – throughout your retirement. You can buy one with some or all of your pension pot or with your savings.
The amount of income you get from an annuity will depend on how much you spend to buy it, as well as various factors including your health, lifestyle and age when you take it out.
Once an annuity is up and running, you can’t usually make any changes to it, swap it or get your lump sum back. So it’s important you do your homework and know exactly what you need from an annuity before committing to one.
Pays a regular income
A key feature of an annuity is that it pays out a regular income that you can rely on throughout your retirement.
So, why’s that important? You’ll no doubt have payments you always need to make, such as for your heating and food. Other than turning the thermostat down a little or shopping around for cheaper options, you don’t have much choice over whether you incur those costs or not.
Reassurance for essential costs
Having an ongoing income to help cover your essential costs can remove the uncertainty of whether you can afford a comfortable retirement.
An annuity isn’t the only income option for retirement. Check whether you’re entitled to receive a State Pension and how much you’ll get. You may also have a 'defined benefit pension' (also known as a 'final salary' or 'average salary' pension).
If you aren’t going to have any other income in place for your retirement, or if your State Pension or defined benefit pension won’t cover your essential costs, an annuity can be a safe choice.
Flexible withdrawals can help cover costs too
It’s also possible to keep your pension invested and then take a regular income through income drawdown that covers your essential costs.
But you should remember that the value of investments can go down as well as up and you could get back less than has been paid in.
If your investments don't grow enough to cover your spending needs, there's a risk that you could run out of money.
A low risk option
Annuities are a good choice if you're not comfortable with taking a great deal of risk with your money.
While keeping your pension invested and taking income withdrawals through income drawdown has the potential to provide you with a higher income, the opposite might happen and you could end up with less income than you would have got from an annuity.
Some people are more comfortable with choices that have a lower risk of a loss, even if they are less flexible.
Downsides of an annuity
An annuity isn’t going to be right for all situations or tastes. The potential negatives are:
- You lose the opportunity to invest in higher risk, higher reward options which could potentially deliver better returns
- Once you buy an annuity, you can’t get your money back out if your circumstances change
- If you don’t add an income guarantee or spouse’s pension, the income paid by the annuity will die with you
- Depending on how long you live, you might get back less from an annuity than you paid for it
- Unlike income withdrawals directly from an invested pension fund, you can’t choose to purposefully adjust the amount of income you receive, for example, to minimise tax
A blend sometimes works best
You don’t need to buy an annuity with all of your retirement savings. It’s perfectly possible to put some money into income drawdown and buy an annuity with the rest.
In fact, a blend of withdrawals from income drawdown and predictable income from an annuity can often provide the optimal trade-off between income security and taking risk to maximise returns on your investments.