Annuity options

Annuity options

The highest annuity income is from a single life annuity with no guarantee period. This is because if the annuitant died the day after purchasing the annuity there would be nothing paid to beneficiaries so the annuity company will have made a huge profit (see mortality cross-subsidy).

Understandably, people don’t like the thought that their annuity will disappear if they die soon after handing their money over, so annuity companies offer several different options to provide continued income or a cash lump sum in the event of early death.

These options include:

• Joint life options
• Guaranteed payment periods
• Value protection
• Escalating payments

Joint life options

A single life annuity pays the highest income but stops on death. Those who are married or have a financially dependant partner should consider the joint life option because if they predecease their partner the annuity pension will continue to them at the percentage selected.

The most popular options are 50%, 2/3rds or 100%, however other percentages are available.

Guaranteed payment periods

This can be thought of as insurance against dying sooner after purchasing an annuity. For example, with a 5 year guarantee if the annuitant dies after 3 years, the remaining two years’ of the guarantee period will be paid to beneficiaries.

Most annuities are guaranteed for 5 years by default, but annuity guarantee periods can be up to 20 years.

  Value protection

Value protection makes sure the annuitant and their beneficiaries get all the original money back even if they die soon after taking out the annuity. On death, the difference between the annuity purchase price and the amount of annuity payments is paid to beneficiaries.

For example, if the annuity purchase price was £ 100,000 and payments were £ 6,000 per annum but the annuitant died after 10 years, the total payments would be £ 60,000 (£6,000 X 10). If the 100% value protection had been chosen, the remaining £ 40,000 would be paid to beneficiaries.

This sounds attractive, but it reduces the amount of annuity compared to an annuity without value protection.

Escalating payments

An annuity that remains constant throughout the life of the policy is known as a level annuity and pays the highest income.

It is natural to want the highest income initially, but it is important to consider an escalating income to protect the effects of inflation.

Escalating payments can be a fixed amount, e.g. 3 or 5%, or in line with inflation. Some company pension schemes may have a limited price increase, e.g. RPI up to a maximum of 3%.

Payment modes

Most annuities are paid monthly but it is possible to have other payment modes, e.g. quarterly.

Payments can be at the beginning of the period, in advance, or at the end of the period, in arrears.