Annuities

When you retire, or continue to work but decide to begin drawing your pension, you have the chance to purchase an annual pension called an annuity. If you are a member of a defined benefit scheme (see Defined Benefit Schemes), you will not need to purchase an annuity. Your defined benefit pension scheme has already agreed the amount that you are entitled to receive each year following your retirement. For example, you are a member of a final salary scheme (see Final Salary Schemes) offering one sixtieth of your final salary for each year's membership. You are retiring after thirty years' membership on a final salary of £44,000. You are entitled to an annual pension of: 30 x 1/60 x £44,000 = £22,000. Your annual pension has already been calculated; you are entitled to twenty-two thousand pounds of pension each year and do not need to purchase an annuity.

However, if you are a member of a defined contribution scheme (see Occupational Defined Benefit Schemes and Personal Pensions) you will need to purchase an annuity. When you come to retire you will be entitled to a tax-free lump sum, up to the value of twenty-five percent of your total pension fund, and the remaining seventy-five percent can be used to secure a retirement income. Essentially, you can sell your remaining pension fund, or your total pension fund if you choose not to have a tax-free lump sum, to an insurance company. The insurance company takes your pension fund and offers you an annual pension in exchange. You are effectively buying an annual retirement income using your pension fund as payment; this is known as purchasing an annuity.

For more details on this topic see articles Calculating your annuity, Deferring your annuity purchase and Types of annuity.