Types of annuity

A pension annuity is one you get by using your pension savings and you don’t have to use all of your pension pot to have one. You can usually take a tax free lump sum of up to 25% from your pot, and use the rest for an annuity that pays you a guaranteed regular income for the rest of your life or a set number of years. You’ll may pay tax on that income, just as you would on a salary.

Unlike the other forms of annuity, a deferred annuity doesn’t pay income straight away. Instead payments start from an agreed time in the future. You might also be able to change the annuity into a lump sum fund to increase the pension benefit options open to you.

A Guaranteed Fixed-term or temporary annuity is a way of accessing some or all of your pension savings to provide you with a guaranteed income for a fixed term, a maturity value at the end of the term, or both, depending on the options you choose. It can help you if you are simply looking for a guaranteed income for a fixed period of time, with the option of doing something else at the end of that time. 

If you die during the term, the rest of the money will usually be paid to a beneficiary of your choice. How this works will depend on your provider and the terms you’ve agreed between you.

An immediate needs annuity can provide a guaranteed monthly payment for life to help pay for the cost of your care fees. If it’s paid directly to your care provider, the income from the annuity is tax free. How much you will receive depends on a number of things including your age, your health, and how much you have to pay towards the annuity.

If you have certain health conditions or habits you might qualify for what’s called an enhanced or impaired annuity. It means the provider thinks you’ll have reduced life expectancy. That might be because of health issues like cancer, heart attack, diabetes or stroke. It might be because you smoke, are overweight, because you work or have worked in a dangerous environment.

This kind of annuity offers a higher level of income because the provider expects it’ll be paid for a shorter amount of time. If you think you might benefit from this option, you might have to answer more questions than you would for other kinds of annuity, and submit a medical history or certificate. You’ll may pay tax on that income, just as you would on a salary.

You don’t have to use your pension savings to buy an annuity. You can also use money from your personal saving in return for a regular guaranteed tax-efficient income. Depending on your needs, you can receive income over a specified term or for the rest of your life.

In most cases HMRC will allow part of each income payment you get as a return of the original lump sum you paid. They class this as the capital element, which means you won’t be taxed on your original payment.

But the difference between the total income payment and the capital element is taxable as savings income.