There are a variety of options available to you with your pension annuity, the income in retirement you buy with your pension fund:
A single-level annuity is the simplest type of pension annuity. It pays out exactly the same amount to an individual (the “annuitant”) every month until the annuitant dies.

A guaranteed annuity pays out an annuity payment each month for at least the length of the guarantee period, even if the annuitant dies before the end of the guarantee period; in which case the guaranteed annuity payments are made into the annuitant’s estate. The maximum guarantee is ten years. Five years is quite common in practice.

With an inflation-linked annuity the annual payments increase by the rate of increase in the Retail Prices Index (RPI) to give payments protection against inflation.

With an escalating annuity the annual payments increase by say 3 or 5 per cent to give the pensioner some protection against inflation and to allow for possible increased income needs as the annuitant ages.

Joint-life or last-survivor annuities pay an agreed annuity payment to an annuitant and the annuitant’s partner while both are alive. Following the death of the annuitant the contract pays either the same amount or an agreed reduced amount each month until the partner dies. The reduction in last-survivor annuities is typically a half to one third.

Investment-linked annuities involve the fund backing the pension annuity being invested in an equity product. The annuitant receives an annuity payment that is related to the performance of the equity market.

An impaired-life annuity pays an increased annuity payment if the annuitant has health problems, such as cancer, chronic asthma, diabetes, heart attack, high blood pressure, kidney failure, multiple sclerosis or stroke.

An enhanced annuity pays a higher annuity payment related to actuarial considerations.

Phased-retirement or staggered-vesting annuities. With these, instead of converting the whole pension fund, withdrawals are scheduled over several years. This is achieved by splitting the fund into many separate segments.

A with-profits annuity links income directly to the performance of the insurance company’s with profits fund. Typically, income is made up of two parts: a minimum starting income and bonuses.

A short-term annuity allows an individual before 75 to use part of a pension fund to buy a fixed-term annuity lasting up to five years. They can choose annuity options in much the same way as basic annuities.

Value-protected annuities pay a lump sum on the death of the annuitant, equivalent to the difference between the original purchase price and total payments made. The lump sum is taxed at 35 per cent. They are only available until aged 75.

With so many choices it is wise to seek out specialist advice when buying your pension annuity.

People approaching retirement, with their pension pot ready to purchase a pension annuity, their retirement income, should be in no doubt that they have a choice of providers when it comes to purchasing an annuity. The message must be far stronger if consumers are to benefit from the highest possible level of retirement income under the Open Market Option.

The Open Market Option gives investors the opportunity to purchase their pension annuity from any annuity provider, regardless of where they have previously invested their pension. All the investor has to do is to find out which provider offers the best annuity rates and options for their circumstances and move their pension pot to that provider.

However, literature from life companies is not clear enough regarding the Open Market Option.  Consumers should be in no doubt that they have a choice of annuity providers and by how much it could increase their retirement income….perhaps up to one-third depending on state of health. 

Pension annuities are complex and consumers need to take advice if they are to receive the best deal.  Factors such as health, or even where the client lives, must be considered as impaired life or postcode annuities can significantly increase income. There are other things to consider, such as death guarantees, inflation increases and widows pensions which will all affect the level of income paid. Only by taking independent financial advice will a person on the point of retirement be sure they are making the right decision and receiving the best available income. This is the service available via this website.

Some thematic work on Open Market Options, recently carried out by the Financial Services Authority, is a step in the right direction, but more needs to be done.

One very strong option would be to force life companies to include open market rates on the quote allowing clients to compare different annuity rates and pension income. At the very least the Open Market Option should be up front and in bold. Some documentation is so unclear it probably wouldn’t be regarded as meeting the Financial Service Authority’s Treating Customers Fairly (TCF) initiative.

That’s right, live in the wrong place with the wrong postcode, and your pension annuity could be less. Your postcode can affect your pocket in some less obvious ways. Companies are increasingly using precisely where you live in the country to pigeonhole you and your lifestyle, using the information to determine how much you will pay for everything from your house insurance to your pension annuity.

They claim this makes the assessment of risk more accurate, and premiums cheaper for everyone, but if you don’t fit the profile or you fall on the boundary you could end up losing out, and quite heavily. This can be seen quite clearly with car insurance and proximity to city centres. 

The theory is that the more affluent you and your neighbourhood are, the longer you live. Glaswegians have an average life expectancy in their early sixties, while people living in Surrey will on average live well into their eighties. The rub is, whilst that is good for the individual living longer with the pension annuity, the more expensive your pension annuity is for the insurance company paying your income in retirement, as it will be paying out for longer. And in recent years, some insurance companies have started taking account of customers’ postcodes when deciding what annuity rate to pay them.

Prudential, a major player in the pension annuity market, argues that the assessment is based on your full postcode, which refers to an average of 14 houses on a street or within a few square miles, but the data about the health and wellbeing of those residents is based only on its existing client base, not the population as a whole.

“Using your postcode to help determine how much you get in retirement seems to be a creeping policy,” says Tony Attubato, from The Pensions Advisory Service. “This is understandable when you consider that Glaswegians typically live to their late sixties whereas those on the south coast often live into their early 80s. But surely a customer’s individual lifestyle and medical situation should determine that risk without taking into account the irrelevant health of those living around them? The difference between annuity rates is significant and those approaching retirement really must shop around for the best rate for their pension pot.”

Therein lies the message. Yes, your postcode can now have an effect on the pension annuity rate you are offered, but there are other important factors which could entitle you to a higher annuity rate; you might smoke, or you might have a condition entitling you to an enhanced annuity or an impaired life annuity. So, shop around.

Some people in the industry, like Lincoln Retirement Income, believe that traditional pension annuities, with their limited choices and inflexible rules, will become a thing of the past. Today’s clients demand and deserve a much more flexible solution, to let them enjoy their retirement in their own time and on their own terms.

A new plan has been launched to reflect this, the Lincoln i2Live plan. It is a flexible retirement plan that provides with: a unique Income Guarantee Option;  investment choice, regardless of age and taking an income;  flexible death benefits for dependants;  the opportunity to select and vary income;  and consolidate pension assets all in one plan to create an overall income strategy (currently excluding Protected Rights).

There are phased retirement options, and one annual statement for all aspects of their Lincoln i2 Live income plan. They claim it is one plan with many options.

Lincoln i2Live combines three retirement planning products in one arrangement. Depending on their needs and circumstances, clients can select an individual product or allocate funds between them at no additional cost, offering control over their financial future; known as:

i2Live Accumulator®: personal pension 
i2Live Drawdown®: income drawdown
i2Live Annuity®: flexible unit-linked annuity

Another insurance company coming in with a flexible annuity product. What we really need is a major UK insurer to get their product launched to stimulate interest in the domestic market.

Here we consider the benefits of pension annuities and why income drawdown should be approached with caution. There really is no argument to suggest that income drawdown will eventually replace pension annuities, although there is a role for income drawdown and variable annuities for the right customer at the right time.

Let’s consider annuitisation. It can work within pension annuities invested in unitised funds thereby enabling a higher lifetime income in exchange for giving up capital on death. There is therefore no suggestion that income drawdown will replace pension annuities simply because drawdown can invest in equities and enjoy the benefit of the equity risk premium.

The critical difference between annuities and drawdown is the impact that annuitisation has on the trade-off between income and death benefits. Higher death benefits result in lower income and vice versa - you can’t magic something out of nothing or magic the risk away.

One major reason why drawdown will not replace annuities is the size of pension funds. Too many are too small; over 75% of current funds are less than £30,000 after the 25% tax free cash has been taken. 

Hopefully, fund sizes will increase significantly in the future and this may lead to higher drawdown take up. But there are always going to be a lot of pensioners with insufficient funds to be able to afford the drawdown route, and who will get better value from buying a new generation pension annuity product.