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Pension Annuity

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In order to convert a pension fund into a pension income an investor will need to purchase an annuity. A pension investor must use their pension fund to purchase an annuity by the time they reach age 75, hence they are often called compulsory purchase annuities. Under certain schemes the investor can take a tax free lump sum from the fund before the annuity is purchased. The investor pays the lump sum that has accrued in their pension fund to an insurance company and in exchange the company would provide them with an income.

An annuity is calculated taking the following into account:

• The value of the pension fund at retirement

• The amount of tax free cash taken

• The type of annuity chosen

• The annuity rates available at the time of purchase – usually linked to gilt yields

• The age and life expectancy of the investor - the annuity income is payable for the rest of the life of the investor so the insurance company will use government life expectancy statistics to estimate how long they are likely to have to pay the income

• Gender - annuities for women cost more due to their higher life expectancy

• Health - insurance companies may pay higher annuities to people in poor health

• Smoker or non-smoker – smokers can often get better rates as they have a lower life expectancy