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Step-by-step guide to buying an annuity

Updated 03 September 2020

5min read

Nick Green
Financial Journalist

Buying an annuity

Buying an annuity is a way to turn some or all of your pension pot into a guaranteed income for life. It’s an income that cannot run out no matter how long you live, so it’s a great source of financial security in retirement. On the downside, you may have to live a long time to get your money’s worth.

If you’re wondering ‘Should I buy an annuity?’ then you can find out about the pros and cons of annuities here. This article assumes that you’re already considering that option, and want to know about the actual process of getting an annuity.

How do I buy an annuity?

Buying an annuity is a fairly straightforward process. However, buying the right annuity for you can be much more challenging. It’s crucial to remember that an annuity is a financial product designed to last for the rest of your life – which could be 30 years or even longer. What’s more, once you’ve bought it, you can’t change your mind or trade it in. Given that you may be spending tens or even hundreds of thousands of pounds on this product, it should be one of the most carefully considered decisions of your life – even more so than buying a house.

Here’s how the entire process works, so you can take the time you need to think carefully at every stage.

1. Build your pension pot

Usually, the money to buy an annuity comes from a person’s pension pot, but you can use money from any source, such as savings or investments. Nevertheless, your pension will most likely be the most effective way to save up the required sum, as it benefits from tax relief, tax-free growth and a very long period of investment. Find out more about growing your pension pot.

If you are planning to buy an annuity, you will want to achieve the biggest pot you can at the point of retirement. This may mean adjusting your investment strategy in the final few years. A stock market dip or crash could severely reduce your savings if they are in high-risk assets such as equities, so a common way to prevent this is to switch your fund into lower-risk assets such as bonds and cash. Some pension schemes do this automatically, but you should ask your provider about this. A financial adviser will also be able to help.

Another useful strategy is to transfer other savings and investments into your pension just before you access the pot. These savings will get a big boost from tax relief, so you’ll be maximising the size of annuity you could potentially afford.

2. You’ll start to receive wake-up packs

In the past, pension savers would receive documents in the post, called a ‘wake-up pack’, about six months before their retirement date. These days there is no set ‘retirement date’, as you can take pension benefits at any age from 55 onwards.

This means that such wake-up packs are now send earlier, and more regularly – you should receive one every five years from the age of 50, until your pension pot is used up.

A wake-up pack is essentially is a nudge to remind you to think seriously about your retirement options and how you plan to take your pension. You’ll continue to receive them as long as you have unspent pension pot, as you can change your plans at any time during this period.

Your pack will tell you the current value of your pension pot, and should also list the types of annuity on offer from your current pension provider, and the rates available. However, there is no obligation to buy an annuity from your current provider (the pack should make this clear), and you should consult an independent financial adviser about where you buy your annuity, what kind to choose, and indeed whether you should get one at all.

Ideally, you should be thinking about your pension options long before your first wake-up pack arrives in the post!

3. Speak to a financial adviser

If you haven’t done so already, your first wake-up pack is a good reminder to speak to a financial adviser. Even if you don’t plan to retire for a good 10 years or more, the choices you will make in the future may influence the decisions you make for your pension now.

Talk to your adviser about your various pension options to try and decide whether an annuity (or another strategy) might be best for you. Your adviser can then recommend a current course of action for your pension pot – even if this is simply to do nothing for the time being.

4. Get annuity quotes

Your current pension provider will offer you annuity quotes, but you can usually find better by shopping around. Your financial adviser can do this for you, and will also know how to achieve the best rates for you.

For example, if you have any of a range of health conditions, or certain lifestyle factors (such as smoking or even living in certain areas of the country) then you may qualify for an enhanced annuity, which will give you a higher income for the same price.

If you have a spouse or partner, you may want your annuity to provide them with some income if you die before them. You may also want a type of annuity that increases over time to counteract inflation. As a rule, the more additional benefits an annuity offers, the more it will cost – so these are decisions to make carefully with the help of independent advice.

5. Purchase your annuity

Once you’ve chosen your annuity deal, you can start the purchasing process.

You can access your pension pot from the age of 55. If you wish, you can exchange the whole pot for an annuity, but you don’t have to. You are entitled to take 25 per cent of your pot as a tax-free lump sum, and usually it makes sense to do this (since income from an annuity will be taxed). You can use as much of the remainder as you wish to buy your annuity.

The buying process itself is essentially a case of transferring funds from your pension pot to your annuity provider. This usually takes around a month. You’ll tell your provider which date in the month you would like to receive your regular income. Your financial adviser can take care of this part of the process too.

It’s important to remember that buying an annuity isn’t the only option for income during retirement. You could set up a drawdown scheme if you want more flexibility with your pension pot, or use a combination of methods. In this article, ‘What pension income will my £100k pot buy me?’, we compare the pros and cons of an annuity only, drawdown only, or a combination of the two. This should give you some idea of which type of approach may suit you best, but isn’t a substitute for personalised advice.

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About the author
Nick Green is a financial journalist writing for Unbiased.co.uk, the site that has helped over 10 million people find financial, business and legal advice. Nick has been writing professionally on money and business topics for over 15 years, and has previously written for leading accountancy firms PKF and BDO.