Annuity Options
Written by
Angela
Reviewed by
Richard
Date
March 2025
What is an annuity?
Types of annuities
How inflation-linked annuities work
Annuity death benefit options
Taxation of death benefits
Other annuity considerations
How annuity choices influence income
The value of shopping around
Next steps
Personalising an annuity to fit your needs
Annuities can be adapted in a number of ways to align with your specific retirement goals.
From payment structures to death benefits, there are various options that determine how income is delivered and whether provisions are made for a beneficiary.
What is an annuity?
An annuity is a financial product used to convert pension savings into a regular income. Payments can be arranged to last for life or for a fixed term, and the income is guaranteed—meaning it won’t fluctuate with changes in interest rates or investment markets.
You can typically use your defined contribution pension to purchase an annuity from age 55, increasing to 57 in April 2028.
Types of annuities
There are several annuity structures, each suited to different retirement priorities:
- Conventional lifetime annuity: Offers a fixed or increasing income for life.
- Enhanced lifetime annuity: Provides higher income if you have qualifying health conditions or lifestyle factors.
- Fixed term annuity: Pays income for a specific period, often with the option of a lump sum at the end. Alternatively, the fund can be left to grow at a guaranteed rate with no income taken.
Income options: level or increasing
Annuities can be structured to pay either a consistent income or one that rises over time:
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Level income: Fixed income throughout retirement. The starting income is higher, but its value decreases over time due to inflation.
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Escalating income: Starts lower but increases annually, either by a set percentage (e.g., 3% or 5%) or in line with the Retail Prices Index (RPI).
How inflation-linked annuities work
If maintaining purchasing power over time is a concern, two escalation options are available:
- RPI-linked increases: Adjusts income based on the Retail Prices Index to reflect changes in the cost of living.
- Fixed percentage increases: Income rises by a set percentage each year, offering predictability.
Pros and cons of inflation protection
Advantages:
- Helps maintain the value of income over time.
- Offers a safeguard against rising living costs.
Disadvantages:
- The starting income will be lower than a level annuity.
- May not be suitable if a higher initial income is needed.
Choosing inflation protection means trading off a lower starting income for the reassurance that your payments will keep pace with rising prices over time.
Annuity death benefit options
Without additional options, annuity payments typically end on the annuitant’s death. However, certain features can ensure that income or a lump sum is passed to a beneficiary.
Common options:
- Joint life annuity: Continues payments to a named beneficiary, such as a spouse or partner, after your death. You can choose what percentage of your income continues (e.g., 50% or 100%).
- Guarantee period: Ensures income continues for a minimum number of years, regardless of when you pass away. For instance, if you select a 10-year guarantee and pass away after 5 years, payments continue for another 5 years.
- Value protection: Pays a lump sum based on the unused portion of your pension fund. You can choose to protect up to 100% of the fund.
Impact on your income
Selecting any of these options will usually reduce the income you receive during your lifetime, as the provider factors in potential additional payments after death.
Who can receive death benefits?
Since the pension reforms of 2015, beneficiaries do not have to be a spouse or dependent. Any individual can be named, subject to provider terms.
The age and health of your chosen beneficiary may affect the income you’re offered, especially with joint life options.
Taxation of death benefits
If you die before age 75, annuity death benefits are typically paid tax-free. If you pass away at 75 or older, the recipient will usually pay income tax at their marginal rate.
October 2024 budget update:
From April 2027, pension savings may form part of the deceased’s estate and could be subject to inheritance tax (IHT), depending on the value of the estate and relationship of the beneficiary. A consultation on these changes is expected to continue into early 2025.
Other annuity considerations
Tax-free lump sum
Up to 25% of your pension fund can be taken as a tax-free cash sum. Doing so reduces the amount left to purchase an annuity, but can offer useful flexibility.
Payment frequency
You can choose to receive income monthly, quarterly, bi-annually or annually. This allows annuity payments to better match your budgeting needs.
How annuity choices influence income
The type of annuity and the options selected will directly impact the rate and income offered. For example:
- Single life annuity: Usually offers the highest initial income.
- Joint life annuity: Tends to lower initial income due to potential longer payment period.
- Enhanced annuity: Offers higher rates if you meet health or lifestyle criteria.
- Escalating annuity: Begins with lower income but increases annually.
- Guarantee period / value protection: Reduce starting income to cover extended or lump-sum payments.
- Fixed term annuity: May provide higher short-term income but only for a set duration.
The value of shopping around
Annuity rates and product features vary significantly between providers. You are not required to purchase an annuity from your current pension provider and can use your Open Market Option to compare alternatives.
Comparing quotes across providers helps you find the best rate and the most appropriate combination of features for your needs. This is particularly important, as annuities are generally irreversible once purchased.
Professional support can help you assess your options and handle the process, including paperwork, ensuring you make informed decisions about your retirement income.
Next steps
Want to see how much income you could really get?
Check the latest annuity rates or get a personalised quote now through Legal & General, Aviva, or use Retirement Line’s annuity calculator to get an up-to-date forecast — it only takes a minute to get started.
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