This article explores how you can choose a retirement annuity and will help you to make decisions about the options available to you. There are many options when considering a retirement annuity, and the decisions can seem daunting. This article will show you how to make these decisions.

Key points

  • About retirement annuities
  • How retirement annuities are calculated (and the options available)
  • How to choose a retirement annuity
  • Claim your free retirement checklist

Retirement decisions

When you are about to retire you need to consider all your income sources, not just your pension plans. Our article on investing for income in retirement explains more. It doesn’t really matter where your income comes from when you retire. What is more important is that you have enough income.

About retirement annuities

Most people opt for a traditional retirement annuity when they retire. This probably means around 95% of people we advise. There are other options available, but this article assumes that you are going for the retirement annuity route.

Traditional retirement annuities are right for most people since they offer security in retirement. You get to swap your pension funds for a guaranteed income for life, on the basis you select. This is a decision which you shouldn’t take lightly since once taken it cannot be reversed. Once set up, the income will be paid for your life and then will cease, unless you have selected other options (see below).

The open market option

Not everyone realises, but you can shop around for your retirement annuity income. you don’t have to take your income from the company you have saves your pension funds with. Of course, your current pension provider will offer you a retirement annuity quotation. In our experience, the difference between the worst retirement annuity income rates and the best rates can be up to 30%. This can be even greater if you have a medical condition.

How retirement annuities are calculated

The insurance company takes your fund and offers you a rate of income based on a number of factors. Essentially, they are trying to work out your average life expectancy. They will take your fund and divide it up by the number of years they think you have left to live on average. Of course, it’s more complicated than that, but that’s the basis of it. Some people benefit from this system (as they live longer). Some people lose out (they die sooner).

  • Age
    The older you are, the fewer years you have left to live on average. Therefore your income rate increases.
  • Health & lifestyle issues
    If you have pre-existing medical conditions you should be able to boost your income rate if these are likely to reduce your life expectancy. Lifestyle issues such as whether you smoke or your weight will also have an impact.
  • Occupation & postcode
    Some companies pay out greater income levels to certain occupations or areas. They consider the data to show whether you are likely to live a different lifespan to the average.
  • Fund size
    Obviously, the larger your pension funds, the larger your income will be.
  • Gender
    Retirement annuities used to pay greater income rates to men (since they tend to live shorter lives than women). Since the EU gender directive came into force at the end of 2012, this is no longer possible. The retirement income rates are now gender neutral.

There are many options open to you. These are the main ones.

  • Tax-free cash
    You can choose to take up to 25% of your fund as a tax-free lump sum. Most people take this as they prefer to have flexibility with their money. This is very much a personal decision.
  • Level or increasing income
    You can choose a level income, which will start higher but never rise. Alternatively, you can choose an income which will start lower but rise in the future at a fixed rate or in line with inflation. The level incomes are attractive since they start higher. Of course, they will gradually lose their purchasing power as inflation eats into the income over time. One way to avoid this is to select an income which will increase over time. The downside of this is that it starts at a lower level.
  • Spouse pension
    Since your retirement annuity income will be lost on your death, you may want to provide an income for your spouse when you die. This will reduce the initial income paid, but could provide a valuable benefit after your death.
  • Guaranteed income
    As your annuity income will be lost on your death, you could select a guaranteed period over which this is paid. Therefore you could select a period of say 5 years. If you die within this period your family will receive the income you were entitled to. This option is often selected if the retirement income needs to cover a particular item.
  • Frequency of income
    You can choose whether to have the income paid monthly, quarterly, yearly etc.
  • Advance or arrears
    Whether you have the income paid up-front, or after an initial period will have an effect on the income rate paid.

How to choose a retirement annuity

We find that the best way to understand how the various options work out is to run a series of comparative quotes. Please remember that the rate change regularly, and are dependent on your individual circumstances. This information is provided for illustration only, so don’t make any decisions on the back of this data!

Our clients get a comparison like this:

Example best retirement annuity comparative quotes


This table shows a number of options so that you can start to see the effect of choosing one option over another. Obviously, further options can also be built in. Behind each of these figures are quotations with around 20 different providers and products.

We then present this visually like this:

Single life retirement annuity quotes


This chart shows how the single life retirement annuity works in practice. You can see that the level retirement annuity starts higher but never rises. After some time the increasing options overtake the level option, though they start lower.

Single life retirement annuity cumulative values


This chart shows the cumulative effect of the different options. The level retirement annuity is ahead in the total amount paid for many years. Eventually, the increasing options take over. What this shows is that in this scenario if you feel you are going to live a shorter life you would go for the level retirement annuity. If you feel you are going to live longer, the other options might look more attractive.

What you should do next

If you are interested in setting up a retirement annuity we obviously recommend that you take financial advice. Contact us if you would like to discuss your options. Alternatively, take a look at our retirement annuity case study.

What to do if you are retiring soon

We have created a handy free resource if you are retiring soon – the retirement checklist. This gives you the top 10 tools you need to know to claim the maximum retirement income. Just complete the form below to claim your checklist.

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Financial Planning helps you to navigate and anticipate significant life changes. I want to help you to ensure your money is managed wisely to give you the financial security that will fund the future and lifestyle that is important to you.