Annuities

An annuity is a type of insurance policy that provides a regular income in exchange for a lump sum. When you reach retirement you have to convert the capital built up in your personal pension policy or with additional voluntary contributions (AVCs) into a regular pension. You can take up to 25% of your pension pot as a tax-free lump sum, but the rest must eventually be converted into an annuity. In one sense, they work as life insurance in reverse. The insurance company that sells you the annuity estimates how long you will live and then uses this as a basis for the amount it will pay you. Everyone who has a pension and has built up a lump sum with their provider must buy an annuity by the time they reach 75. The exceptions are those who are part of a workplace final salary scheme, but, as these are becoming less common, most people are currently faced with the annuity option. Over the past few years, annuity rates have fallen sharply and a 65-year-old man now earns a typical return of just 8% from his pension fund. Therefore, with a pension fund worth £100,000 he would receive an annual income of £8,000. You do not have to take the annuity offered by your existing pension company. Annuity rates vary between companies so you need to check which one will give you the best deal. Switching could boost your pension by hundreds of pounds a year or enable you to invest in a different type of annuity that better meets your needs.