If you have a significant amount of capital behind you, you might want to consider early retirement.  Purchasing an annuity could help you to realise this dream.  Here's a beginner's guide to annuities; how they work and what one could do for you.

What is an annuity?

An annuity is a type of fiscal policy that allows the conversion of your pension pot into a regular income for life.  You'll be paid at a percentage rate which offered to you by the annuity provider, and multiplied by your initial investment.  For example, if your pension pot is $200,000 in total, and you are offered an annuity rate of 6%, then your yearly income will be $12,000. 

Different types of annuity

There are many different types of annuity available so you should be able to choose one that suits you.

  • Single life annuity:  you receive all the income
  • Joint life annuity:  should you die before your partner, the income will continue to be paid to them
  • Escalating annuity:  your income will increase annually in line with inflation
  • Enhanced annuity:  this kind of policy will pay more if you suffer from ill health or have a medical condition
  • Investment annuity:  your money is held as an investment in order to give you a higher income
  • Flexible annuity: these are complex products that pay a guaranteed income, and hold a percentage of your pension pot as an investment
  • Fixed-term annuity:  after an agreed fixed term these policies pay out a lump sum

Who can buy an annuity?

You can only buy an annuity if you have paid into a personal or workplace pension scheme.  However, you will automatically receive an income if you have a defined benefit or final salary pension, so you might not need to buy an annuity.

If you are unsure whether an annuity is right for you, have a chat with your pension scheme manager or financial advisor to discuss your options.

What are the advantages of buying an annuity?

The most important benefit of an annuity is that you will receive a guaranteed fixed income until you die.  This income is not at the mercy of the stock market, and the value of your original investment is therefore safe.

By choosing an annuity policy that escalates in line with inflation, you can ensure that your income will keep up with the increasing cost of living as you become older. 

If you suffer from ill health, choose an enhanced annuity.  This type of policy pays out more because the expected duration of your policy is relatively short.  The insurer will ultimately have to pay out less, due to your decreased life expectancy.

What are the disadvantages of annuities?

Once you've invested your money in an annuity, you can't switch insurers to try to find a better deal.  In addition, you cannot bequeath your pension pot in your Will as part of your estate even if you die before the whole of the original investment has been paid out.  Annuities work on the premise that policyholders who die younger effectively pay for those who live longer.  Consequently, the longer-lived are paid out more than their original investment figure.

Another disadvantage of annuity policies is that rates can vary.  This is because the rate is based on the investments the annuity providers use to fund the products they offer, and rates can fluctuate.  Also, investors are living longer so rates are adjusted downwards accordingly.

In conclusion

Annuities can provide you with a regular and secure income in your retirement.  However, they are complicated products that can be confusing.  Always seek professional advice from your financial advisor before investing in an annuity product. To learn more, contact a company like Maddern Financial Advisers with any questions you have.