What is a Pension Annuity?

A pension annuity is what many people contemplate when they think of the term ‘pension’. While a pension fund is the accumulation of pension in the form of a lump sum, an annuity is the product that allows you to draw on your pension in the form of a regular income during retirement.

A pension annuity is basically a tool that, in exchange for your pension fund, makes guaranteed regular payments for the rest of your life. Simple pension annuities are not linked to external investment products and can therefore make guaranteed payments. There are lifetime annuities, as well as fixed term annuities that only pay out during a fixed term of five or ten years. Pension annuities are generally available after the age of 55.

While it is possible to purchase an annuity with any lump sum cash, pension annuities are most commonly set up using pension funds. There is, however, no limit to how many pension annuities one can have, as long as one needs and can afford them. It is not necessary to purchase the pension annuity from your pension provider and the open market option gives you the freedom to shop around for the best deal.

After the age of 55 it is possible to unlock your pension fund and release the pension either as a tax free lump sum or purchase an annuity and set up regular payments. Not all the cash in the pension fund can be withdrawn tax free however, and currently 25% of the fund can be released as a tax free lump sum.

You may wish to shop around for the most suitable annuity and therefore may only wish to release tax free cash and set up no payments. Alternatively, you may wish to release 25% of the fund and set up an annuity using the remaining fund. Since it is not possible to change an annuity once it has been set up, it is important to take your time finding the most suitable option for you.

Pension annuities are provided by insurance companies, and the rate of interest for annuities depends on the age and health of the applicant. Just as with life insurance, the term over which the insurance company expects to pay the annuity will determine how much you receive. In general, the longer you are expected to live, the lower the rates insurance companies can afford to pay.

Different types of pension annuities are available on the market. There are annuities that guarantee income throughout life, and fixed term annuities. There are annuities that are linked to investment products and the stock market, joint annuities, enhanced annuities for those suffering from certain illnesses and escalating annuities. Setting up an annuity is a very important decision, and it is therefore advisable to consult a financial advisor with expertise in the retirement sector before investing.