What is a Pension Annuity?
Author: Steve A Wright

When the investment in your personal pension plan reaches
maturity when you retire, you will need to transfer its
accumulated value into a regular income for the remainder of
your retirement. This is achieved through the purchase of a
pension annuity – a seemingly simple and straight forward
transaction that exchanges the final value of the pension fund
into which you have been paying into a regular income.

Whilst the principle of a pension annuity is seemingly very
straight forward, however, things are rarely quite as simple as
they seem.

The first and probably most critical aspect of buying a pension
annuity is that it is a long-term, one-off commitment. You have
just one shot at it, since there is no going back and asking for
a refund of all of the capital simply because, after the event,
you have found a better deal elsewhere. In other words, it is
very important that you make the right choice.

Making the right choice is made no easier by the fact that a
host of different annuities all offer a host of different
annuity rates – i.e. will offer a different level of income for
the same amount of pension investment.

The difficulty is further compounded by the sheer number of
different types of annuity available these days.

Standard annuity – the most conventional form of annuity is one
that pays you a fixed income throughout the remainder of your
life. The income is known in advance, so you have the security
and peace of mind in knowing just how much that will be;

With profits annuity – as the name suggests, this relates the
income you receive to an element of your initially invested sum
that is in turn invested again in equities, bonds and gilts. In
this way, your annuity reflects some of the risks inherent in
such investments;

Unit-linked annuity – this is probably the choice for those
prepared to take the greatest risk on an annuity that is
entirely subject to the fluctuations of the investments made;

Immediate ("temporary" or "purchased life") annuity – this form
of annuity needs to be purchased either from the cash element of
your matured pension fund or some other cash resource. The
advantage of this kind of annuity is that part of the annuity is
treated as a return of your initial capital and, therefore, is
not taxed, whereas the whole of your pension annuity would be
subject to income tax;

Impaired life annuity – this is a type of annuity designed for
those whose actuarial life expectancy is lower than someone of
the same age in the general population. Different annuities will
operate different definitions of what amounts to "impairment" of
life, but it is generally a question of an existing serious
illness or lifestyle factors such as smoking, obesity or past
occupation.

Summary

The seemingly simple and straight forward question of
converting the final value of a pension fund into a regular,
income-paying annuity actually requires the kind of advice you
can best receive from an independent financial adviser, since:

•Your pension annuity decision is of a one-off type that you
need to get right the first time;

•There is considerable variation in the level of income paid by
any one annuity – naturally, you would want the highest paying;

•There is a wide range of different types of annuity – some
higher, some lower, risk – an independent financial adviser will
be able to help you choose the one you want.


About The Author: Steve Wright is Managing Director of
Wrightway Financial Consultants (http://www.wrightwayifa.co.uk),
Independent Financial Advisers specialising in Pensions,
Investments, Mortgages and Insurance.