Positive net receipts for the Government have meant a much reduced supply of gilts. New legal requirements for pension funds to hold more of their assets in fixed-interest gilts have created more demand for gilts, pushing up gilt prices and reducing their income yields. As a result, annuities, which use gilts to provide income for pensioners, are paying out less. So if you are planning to retire in the near future with a personal pension or money-purchase company pension, you need to find the best possible annuity for your needs.

What is an annuity?

An annuity is the insurance contract you have to buy if you retire with a personal pension or money-purchase company pension, and it is meant to provide you with a pension income for the rest of your life. However, a standard annuity can only pay you an income based on interest rates on the day you buy it. If interest rates are high, the yield offered by gilts (fixed-interest government stock) is usually also high. If interest rates are low, gilt yields and hence annuity rates are likely to be reduced.

What are your options?

Investment-linked annuities
Annuities linked to investments pay a variable level of income for the rest of your life, based on the performance of an investment fund. Income levels are set according to the anticipated rate of growth of the underlying investment funds and the optional extra benefits you choose. 

These are the options if you have a personal pension or a company pension scheme that will let you choose an investment linked annuity: 

With-profits annuity This type of annuity invests your pension fund in a with-profits fund of shares, property and fixed interest investments, to produce an income. Each year, the investment returns are used to add bonuses to the fund. 

These bonuses are only calculated once a year, though, and they vary. So in the first year, you choose an anticipated bonus rate (ABR) from the provider's estimates and that is used to provide your initial income. In following years, if the actual annual bonus is higher than your selected ABR, your income will increase; if it is less than your ABR, it will fall. If you want more certainty, you can choose a guaranteed with-profits annuity, which pays a lower initial income but guarantees that this income will not fall below a minimum level. 

Unit-linked annuity This annuity allows you to re-invest your pension fund in a range of investment funds. The investment fund is divided into units. Each year the investment returns from the fund are converted into new units and an annuity income is paid, which is equal to the value of the new units. 

Here again, in the first year you choose an anticipated growth level and an initial income. Then, in following years, your annual income may increase or fall depending on the actual growth level achieved. 

Self-invested unit-linked annuities let you choose your investments rather than use a unit-linked fund.

Impaired life annuities
These work just like standard annuities, but pay a higher level of income if you have a shorter than average life expectancy. So they are as safe as standard annuities, as the income from them cannot fall – but they do carry the risk that you may not live long enough for the total income to equal the value of your pension fund. 

These are the ways in which you could get a higher income:

Standard impaired life annuity These annuities pay a higher level of income if you have had an illness or major surgery that is likely to reduce your life expectancy. You can buy a single-life impaired life annuity based on your medical conditions, or a joint-life impaired life annuity. 

Smoker's annuity This type of annuity pays a higher level of income if you have smoked ten or more cigarettes per day for the last ten years. It will continue to pay this level of income even if you stop smoking after buying the annuity.

Lifestyle annuity Lifestyle or 'socio-geographic' annuities pay a higher level of income if you have worked in certain industries or lived in certain areas that might affect your life expectancy. 

Long-term care annuities
Long-term care annuities will pay a higher level of income if and when you need to receive residential care, so they can be a good way of providing a safe fixed income to help pay care fees. 

You can arrange annuities for your care needs as follows:

Immediate needs annuity An immediate needs annuity must be taken out at the time you go into care and pays a higher level of income than a standard annuity based on your life expectancy in care. And following a change to the tax rules, the income is now free of tax if it is paid directly to a residential care home.

Pre-funded care annuity This type of annuity pays an income that is between the income from a smoker's annuity and a standard annuity – but this income doubles if you go into care. Income levels are reviewed every five years before the age of 70 and every year after the age of 70. 

Free to choose

You are under no obligation to buy your annuity from your pension provider. A company that is good at investing pensions may not be a competitive annuity provider. This choice of annuity providers is known as the Open Market Option. 

For more information about how you can maximise your income during retirement, please e-mail or contact us or use our online advice service.