Purchasing an annuity guarantees you an income in retirement for either a set period of time, or for the rest of your life. There are several types available:
Flexible Lifetime Annuity - You may transfer your pension fund to a provider that offers a lifetime annuity on a flexible basis (often called variable or third way annuities). These types of annuity attempt to combine the certainty of a conventional lifetime annuity with the prospect of investment growth seen with drawdown pension.
Flexible annuities generally fall into three main categories:
- Annuities with Flexibility - Similar to conventional Lifetime Annuities i.e. payable throughout lifetime but come with a degree of income and/or investment flexibility.
- Fixed Term Annuities - These provide a guaranteed income for a set period of time with a guaranteed or reviewable maturity value.
- Drawdown Pension with Income Guarantees - Similar to Drawdown Pension Plans but with some level of underpinning income guarantee that will continue no matter how the underlying investment performs. Some plans provide an income for life, whilst others guarantee is for a specific time period.
With-Profits Annuities - You may use the whole of your pension fund (after any tax-free cash has been paid to you) to purchase a With-Profits Annuity with your existing or new provider. This provides an income that is linked to the investment returns of an insurance company’s With-Profits Fund. As for all investment linked annuities, the income payable can go down as well as up in the future. With-Profit Annuities do however provide smoothed investment returns, so this option can be less volatile than other investment funds.
Unit-Linked Annuities - Similar to With-Profits Annuities, you can purchase a Lifetime Annuity on a unit-linked basis with your existing or new provider. With this, your income in retirement will be linked directly to the value of an underlying fund of investments.
Your starting income is based on an assumed growth rate, and if the fund grows at that assumed rate, your income stays the same. If growth exceeds the assumed rate, your income increases, and if growth is less than the assumed rate, your income falls.
A few Unit-Linked Annuities let you invest in a “Protected fund” which limits the fall in your income. Most do not guarantee any minimum income. Even if your income is based on an assumed growth rate of 0%, your income could still fall if the value of the underlying investment fund falls.
It isn’t necessary for all of the benefits to be taken from a personal pension at the same time – you can opt for phased retirement. Some personal pensions are not arranged as single plans, but as clusters of many smaller separate plans, sometimes called segments. Segments can then be used to buy annuities at different times. It’s no longer necessary for a personal pension to be physically split into segments in order to take benefits at different times – the pension provider would just need to know how much of your pension fund you want to take benefits from.
Each time you convert a segment to an annuity, you can first take part of the portion’s fund as tax-free cash (normally 25%). Converting portions of the fund regularly, e.g. once a year, means you can effectively use the tax-free cash, as well as the annuity, to provide you with your income.