Types of Annuity – Overview
What is an annuity?
Purchasing an annuity is a traditional option for many approaching retirement age. You exchange a lump sum of money, usually accumulated by saving through a pension plan throughout your working life, for an annuity. An annuity is a guaranteed income that you will receive regularly after you retire, until the time of your death. Different factors and circumstances can influence how much retirement income you receive. You also need to choose which type of annuity you would like to purchase.
Types of annuity
This ‘standard’ type of annuity will essentially pay the same amount to you each year for the rest of your life but you should receive a slightly higher amount when you begin your retirement. This annuity is dependent on inflation, however, so the real value of that annual amount could decrease over the time of your retirement. As retirement may last over 30 years, you need to consider whether the amount your annuity provider can offer you, will continue to keep you financially secure even if inflation has a negative effect. Consider it in these terms: at the beginning of your retirement, your weekly food shop costs around £50. However, if inflation causes prices to rise, your shopping list could increase to around £70 a week. This could be a problem if your annuity income can’t support too many rising expenses.
In this case, you would exchange a smaller cash sum with your insurance company for a short-term annuity. For example, you might stick with this annuity for 5 years. At this point, your payments will end and you can reconsider your annuity choices depending on your circumstances.
Thinking of Retiring Soon? Have a look at our Annuity Comparison Table
If you made this choice, at the beginning of the annuity, you would select an annual rate of increase. This choice is often made to protect the purchaser from rising inflation. There are two types of increasing annuity that you can choose. There is an escalating annuity, which as described, rises at around 3-5% every year. There is also a Retail Prices Index (RPI)-linked annuity, in which your income will rise and fall in relation to inflation. Although the potential increases of this annuity are attractive, you need to consider the fact that you will be starting with a lower retirement income, and it could take a very long time to catch up to the income of a Level Annuity.
With this method, you may pay a single payment, or multiple payments to your annuity provider at the beginning of your retirement, but you will not receive an income for perhaps months or years after. You could possibly benefit from rising annuity rates, but due to several affecting factors, it is very difficult to predict whether you will or not.
A fairly risky type of annuity that depends on how well your fixed-interest assets, such as bonds, perform in the stock market. If you made this choice, you will be subject to possible sudden drops and rises in the stock market. For some, the chance of increasing their retirement income this way is very appealing, but it is not a recommended method for anyone who is not comfortable with taking some risk with their retirement savings.
There is a wealth of options available to you when purchasing an annuity. It is recommended that you shop around before buying, and consult a financial expert to determine which choice is the one for you.