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The type of annuity which you buy with your pension fund is chosen at the beginning and cannot be changed. So it’s worth knowing what the options are, what they will provide, and how much they will cost you. The cost manifests itself as a reduced income – so, for example, if you choose an inflation-linked annuity, you will get a lower income initially, but it will grow over time.

Single-life and Joint-life Annuities

A single-life annuity pays you an income for your life and ceases on your death. On the other hand a joint-life annuity will continue to pay out – typically to your spouse - after your death. How much it continues to pay is your choice, and half or two-thirds of the original income are common choices.

If the annuity was bought with “protected rights” money (that part of your pension plan which accrued from being contracted out of the relevant state scheme) then the annuity must be set up on a joint-life basis if you are married.

Level and Escalating Annuities

A level annuity pays the same amount of income throughout your life. In effect this means a reducing income since inflation would mean you could buy less and less with that fixed amount. An escalating annuity could grow with inflation (e.g. the Retail Prices Index), or at a fixed rate (e.g. 3% per year).

The choice between level or escalating is a difficult one. You will not want your income being reduced in value, but on the other hand an escalating income costs a lot – in other words you will get a much lower initial income, and it may take 20 years before the escalating income reaches the same level as you could have been receving on a level annuity.

Investment Linked Annuity

In this case, your retirement fund is invested, and your income is linked to the performance of the investments – it could go up or down.

Annuity Protection

With this option, if you die before 75 (the age is currently under review) then your annuity can provide a lump sum. This would be subject to a tax charge, but does at least mean that if you die earlier than expected the money you put into your annuity and have not yet “used” is not completely lost.

Guarantee Period

In a similar vein, if you die within a couple of years of buying an annuity then you (or your estate) could lose all entitlement to that money. But if you buy a guarantee period (typically five or ten years) then the income continues to be paid up until the end of that time.

If you select a joint-life annuity then a guarantee period is less useful since your spouse would in any case continue to receive some income assuming they survive you.

Enhanced or Impaired Life Annuity

Higher annuity incomes (“Enhanced”) are possible if lifestyle factors indicate that you may have a shorter life expectancy than average. This might include smoking or being overweight. Apart from lifestyle factors, health issues which threaten to shorten your life would enable you to purchase an "Impaired Life" annuity – generally subject to medical underwriting.

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Last reviewed 29th October 2010