Page last updated at 12:07 GMT, Thursday, 6 April 2006 13:07 UK

Q&A: Annuities

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An annuity provides an income in old age

As part of its understanding pensions series, the BBC News website provides an introduction to annuities.

What are they?

If you have a money purchase pension scheme, you can use the cash you have saved to buy an annuity.

This effectively "unlocks" the money that you have saved in your pension fund to provide an income in retirement.

The amount you get will depends on your age, sex and medical history - and the current annuity rate.

The problem facing people retiring now is the poorer annuity rate on offer.

The rate is crucial because it determines how much income a person will receive for the rest of their life.

What determines annuity rates?

Annuity providers invest largely in ultra-safe government stock, and the rates of return available from this type of investment is closely linked to the Bank of England base interest rate.

The Bank of England base rate is currently at a very low level. This means the return on government stock is poor and annuity rates on offer to people retiring now are lower than they have been.

Are there any other options?

In the current annuity rate climate, many people are having to revise their retirement plans.

When retirement age is reached, the pension scheme manager will write outlining the annuity rate that they currently offer.

However, pension scheme members have the right to shop around for the best annuity rate, under an "open market" option - and can often get a better deal by doing so.

Members of personal pensions and stakeholder schemes can also normally take up to 25% of their fund tax-free.

Also, if you are a member of a group personal pension or a group stakeholder plan, you can take up to 25% of your fund tax-free.

When you take your tax-free lump sum you usually have to buy an annuity with the rest of your fund.

Can you ignore annuities?


Since 6 April 2006, pension savers have been able to ignore the option to buy an annuity altogether.

Instead , people can now drawdown an income direct from their pension fund; leaving their pension cash invested.

However, any money left in their pension fund on death could be liable to an Inheritance Tax (IHT) charge.

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