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Pension: which annuity is right for me?

In part two of our guide to retirement income we explain the various types of annuities and how they work.

 

by Michelle McGagh on Feb 10, 2012 at 00:05

Pension: which annuity is right for me?

This is the second part of our guide to retirement income and annuities. If you're new to the topic read part one first.

There are lots of annuity providers offering different types of products, and although they are all based on the principle of providing income in retirement in return for a lump sum, the type of annuity can vary.

Level annuity

A level annuity is also known as a standard annuity, and pays out a set amount in income each year for the rest of your life.

This all sounds very straightforward, but you have to remember that inflation will mean the income your receive will be worth less and less as time goes on.

A sum of £50 may buy all your shopping for the week now but in a decade the cost of your groceries will have likely increased, but the income will not.

Increasing annuity

An increasing annuity will help protect your income from the effects of inflation. The income provided is increased over your lifetime, which typically means you will get less income than a level annuity at the beginning, but as the income increases it will be worth more.

The income rises by either a guaranteed fixed amount each year or by linking to the retail prices index (RPI), the cost of a basket of goods and services. If RPI increases 3%, your income will go up by the same amount, but if the index does not move, or worse, falls, then your income will stay the same or fall.

When looking at increasing annuities, you have to gamble that you will live long enough to benefit. You do not want to take a reduced income in the early years if you are not going to be around long enough to take the increased income.

Investment-linked annuity

The income offered through conventional annuities has been in decline, and some savers have put their retirement savings into an investment-linked annuity in a bid to get an increased income.

These annuities are linked to the ups and downs of the stockmarket, meaning your income will increase when the stockmarket goes up but fall when the stockmarket drops.

You could get a bumper return from an investment-linked annuity, but you have to take a higher risk with your money.

With-profits annuity

A with-profits annuity is a type of investment-linked annuity. The income is linked to the performance of the annuity provider’s with-profits fund.

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