Types of Annuity

An annuity guarantees an income for life so for many people, even following the significant changes to pensions legislation which has given greater freedom and more options open to those about to retire, this will probably still be the best option available.

With many pensions however, their annuity does not have to come from the provider of the scheme that their pension contributions have been paid into.

The first thing to consider is whether to exercise the open market option.

If another provider offers better annuity rates, thereby providing a higher pension, the fund can be transferred and the pension then starts immediately with the new company. Scouting around the market for good deals may affect income levels by as much as 30% to 40%.

There are 3 main types of annuities available as follows:

  • Joint Life Annuity
  • Level or Increasing Annuity
  • Enhanced Annuity and Impaired Annuity

Joint Life Annuity

Joint Life Annuities are suitable for people who have a financially dependent person or persons. A joint life annuity will allow pension payments to be made to this person in the event of the death of the pension scheme holder.

When it comes to a spouse or other older dependent, the annuity buyer decides the percentage of the annuity payable to the dependent.

If the dependent is a child, the income from the annuity continues until a certain age.

Joint Life Annuity and Guarantee Period

Another annuity option is to guarantee then income for between one and ten years, regardless of whether the pension holder dies during this time-frame.

Usually, annuity income is payable for life and ceases when the pension holder dies.

If you have selected a Guarantee period, the annuity payments will continue to be made to a beneficiary or beneficiaries even after your death.

These payments are subject to tax. Furthermore, to guarantee retirement income for a period after your death will possibly lower retirement income whilst you are alive.

Joint Life Annuity, Guarantee period and overlap

If you have selected a guarantee period as part of your joint life annuity, it is also necessary to select whether, in the event of your death, annuity payments start during the guarantee period (known as With Overlap) or after the guarantee period (Without Overlap).

Adding Annuity Protection to a Joint Life Annuity

Adding annuity protection (sometimes called value protection) provides the option of paying the value of the pension fund, less the annuity income you’ve received plus taxes to the nominated beneficiary.

Furthermore, the pension holder can decide at what point the benefits are paid. If you protect your pension savings, your retirement income whilst alive will be lower

Level or Increasing Annuity

Inflation can erode pension income over time, however there are annuity options to try and prevent this. For instance, you can choose to increase your retirement income on annual basis.

This can be achieved by setting a fixed increase (up to 8.5% over the course of a year), or by linking your retirement income to the Retail Price Index.

Starting income

However, the starting income from an increasing annuity is likely to be lower than the starting amount of a level annuity that does not increase.

Furthermore, it may take several years before increasing annuity income reaches the same amount as a level annuity. Once this amount is reached, the income will continue and a higher annuity income is possible.

Enhanced Annuity and Impaired Annuity

Although annuities are a long-standing financial services product, enhanced annuities and impaired annuities are relatively recent additions to the market.

The basic premise is that due to lifestyle or medical conditions, postcode and occupation an annuity buyer may qualify for a different type of annuity, known as either an enhanced annuity or an impaired annuity.

Currently, only a small proportion of people think that they could qualify for an enhanced or impaired annuity uplift, and do not take advantage of this opportunity. Failing to recognise that you qualify for an enhanced or impaired annuity could mean losing out on significant increases in retirement income.

Why might I qualify for an enhanced annuity or an impaired annuity?

Literally thousands of conditions might mean someone qualifies for an enhanced annuity or an impaired annuity.

These can include common chronic diseases such as asthma or diabetes, or serious medical problems such as heart attacks or types of cancer. In reality, conditions that are well-controlled and endured by the patient as part of daily life may qualify them for an enhanced or impaired annuity, particularly if more than one condition is present.

How does an enhanced or impaired annuity benefit me?

A retiree purchasing a pension annuity could see their retirement income soar, particularly if a combination of conditions can be shown.

For instance, a person that smokes and has diabetes could see a large increase in their retirement income.

Enhanced or impaired annuity determination rule

Every annuity provider has a different definition or rating for different health conditions. For instance, enhanced annuities may cover minor conditions whilst impaired annuities cover major conditions.

Applications for these annuities are based on a points score card. In some cases, the pension company may ask for a doctor’s report, and will base the increased retirement income on this report.

Some companies cover the cost of the medical report or roll it up into the annuity, whilst some companies require the patient to pay for their own medical report.