What is an annuity?

An annuity is an income for life provided by an insurance company in exchange for a pension fund or any lump sum. The bigger the pension pot, the bigger the income will be.

When to buy

You can buy an annuity at any age from 50 to 75 although from 2010 the minimum age increases to 55.

Before buying, it is possible to take 25 per cent of your pension fund as a tax-free lump sum on retirement.

How to buy

You do not have to buy your annuity from the same company that runs your pension. The difference between the best and worst annuities can be as much as 25 per cent so it is always worth shopping around.

The Financial Services Authority has a regularly updated and independent annuity comparison service at www.fsa.gov.uk/tables.

Before comparing annuities choose whether you would like your retirement income to remain at the same level for life, increase at a fixed rate each year, or change in line with inflation.

The more you wish to have your annuity increase by each year, the less the starting income will be.

It is also possible to choose an annuity that is linked to a with-profits fund or unit-linked investment. With these types of annuity, the income varies depending on the performance of the investment.

When choosing an annuity you must decide whether it should pay an income to your spouse or partner after your death. The income can continue in full or be reduced to 67 or 50 per cent of the original amount.

Having a joint-life annuity will substantially reduce the income you will receive because the annuity will need to be paid for longer.

Things to consider

If there is a history of ill health in your family, or you are a smoker, you might be eligible for an "impaired life annuity", which pays a higher income because your life expectancy is shorter.

Research show that 30 per cent of retirees could be eligible for impaired life annuities but to qualify you will need to supply evidence and/or undergo a medical test.

Unless you have a joint-life policy you cannot bequeath an annuity to your family.

Unless you have an in-depth knowledge of pensions it is always worth taking professional advice before deciding on an annuity because once it is brought it cannot be changed.

For more on pensions visit www.timesonline.co.uk/pensions

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