Annuities: The options available

It's important to understand the options available to you when you buy an annuity. Like all things, there are pros and cons to each. Which option suits you depends upon your circumstances and attitude to risk.

Level Annuity
Income will not increase in payment. It provides the annuitant with the highest attainable income from outset compared to other options. However, as time goes by and inflation sets in, the value of the pension, in real terms, decreases. In the case of someone who retires early and then lives a long time, this reduction in 'buying power' could be considerable.

Joint-Life Basis
With this option, either a full or reduced income will continue to be paid to the partner if the annuitant dies. Because women tend to live longer than men, a wife several years younger than her husband could reduce the income payment offered at outset significantly. Joint life annuities are usually taken out by married couples, especially when the spouse has no other independent pension income.

Guaranteed Annuity
It is possible to ensure that the income to be paid is guaranteed at a set level for a period of time after the death of the annuitant. Typical guarantee periods may be 5 or 10 years. This option will almost certainly reduce the starting income.

If the annuity is on a joint-life basis and both parties die within the guarantee period, the payments will continue to be paid to the deceased annuitant's estate.

Escalating Annuity
These provide an income that will increase annually at a predetermined rate, or sometimes in line with the retail price index. The advantage of this is the income provides some protection against inflation. However, the initial starting income will be reduced in comparison to a level annuity.

With or without overlap
Applicable when a joint life guaranteed pension has been chosen. With overlap, the spouse/dependent's pension will commence immediately upon the annuitant's death. Without overlap, the pension will commence at the end of the guaranteed period or immediately upon the annuitant's death, whichever occurs latest.