How to buy an annuity
If you have pension savings, one of the options available to you when you retire is to buy an annuity.
An annuity is a guaranteed regular income, either for a fixed period of time or for life, that you’ll receive in exchange for a lump sum from your pension pot.
Read our guide to annuities for more information on how annuities work.
Until recently, an annuity was the only feasible option for most people to turn their pension savings into a retirement income. However, 'pensions freedom' changes to the law mean that, since April 2015, from the age of 55 you can take an income from your pension pot however you want, for example by taking income drawdown.
From the age of 55, you also have the option to take up to 25% of your pension pot as a tax-free lump sum. You can then use the remainder of your pension pot to buy an annuity or generate an income in some other way.
Read our guide: alternatives to buying an annuity.
Stages of buying an annuity
If you decide that an annuity is the best option for you, the stages of buying an annuity are:
1. “Wake-up” pack and follow-up
Up to six months before you retire, your pension provider will send you a “wake-up pack”. This includes a valuation of your pension pot, information about the different types of annuity, and a reminder of the importance of shopping around. This pack should also list which types of annuity your pension provider offers. This is your chance to start looking at the market, and thinking about which retirement income option may be right for you. Ten weeks before you retire, they will send you a follow-up communication which will stress the importance of making a decision.
2. Shop around – exercise your Open Market Option
You don't have to buy the annuity offered to you by your pension provider. You can usually shop around – also known as using the open market option – to look for a higher annuity rate. It is estimated that UK retirees lose £1bn worth of retirement income every year because they don't shop around.
However, if your pension provider offers a guaranteed annuity rate (GAR), it might be a lot more competitive than most deals on the market. Always check; always get annuity quotes from them and from other providers.
3. Get help if you need it
At this stage, many people choose to take financial advice. The best option for you will depend on your personal circumstances, including whether you have a partner, your health and lifestyle (certain conditions could mean that you qualify for an enhanced annuity and a better rate) and whether you have any smaller pension pots. A financial adviser will go through all this with you, and make a recommendation based on your personal circumstances. If you decide not to use an adviser, your pension provider will have to make sure you've considered all the possibilities.
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4. Get quotes and make a decision
When you approach an annuity provider, they will give you a personalised illustration of your annuity, including the rate you will receive if you choose to go ahead. Once you've made your decision, your pension provider will release the money in your pension pot to your annuity provider, and your annuity should be ready within 30 days.
Alternatives to buying an annuity
Since 'pension freedom' legislation was enacted in April 2015, everyone has the option to withdraw as much of their pension as they like from the age of 55, meaning that an annuity is no longer the only option available.
If you would like to begin thinking of other ways to fund your retirement, read our guide: alternatives to buying an annuity.
As always, if in doubt, make sure you speak to a financial adviser.
Last updated: 04 July 2016