Approaching retirement can be a daunting time, with rafts of paperwork arriving from pension companies asking you to make choices about the future income you will receive for the rest of your life. These decisions are of huge importance as once made, they can rarely be undone in the future.
The vast majority of people retiring today opt for an annuity to start to receive their pension income and there are two main types of lifetime annuity available:
Conventional annuities: The pensioner’s money purchase pension pot (less any tax free lump sum taken) is used to buy an annuity contract from an insurance company. This annuity contract provides a pension income that will be paid for the rest of the pensioner’s life. The pensioner can choose to have various options built into the annuity contract.
The amount of pension paid from the annuity contract will depend on the size of the pension pot, the health of the annuitant, the pension options chosen and market conditions when the annuity is bought.
Advantages: Simplicity and security. Disadvantages: Lack of flexibility and current poor annuity rates
Investment linked annuities (including with-profits annuities): The pensioner chooses which funds the contract is invested in and this means that the pension income can go up or down depending on the investment performance of the units in the pensioner’s chosen funds. All investment linked annuities therefore carry some degree of investment risk, but have the potential for rising income over the retirement years.
Advantages: Flexibility over initial pension level and growth potential. Disadvantages: Investment risk and pension income can go down.