Conventional Annuity

The most common type of lifetime annuity, a conventional annuity, guarantees at the outset how much income (before tax) you will get from year-to-year. This allows you to easily budget your outgoings against your income. Example annuity quotes are shown on the standard annuity rates page.

Advantages of a conventional annuity

A secure level of income

A conventional annuity provides a known and secure level of income for the rest of your life. It provides an income for life – an insurance against living too long and outliving your means. You can choose to have your income (before tax) increase at a fixed rate per year, or in line with the Retail Prices Index (RPI), and help offset the impact of inflation.

Disadvantages

Look out for inflation

The buying power of a conventional annuity may not keep pace with inflation, even if you choose an increasing income (aside from RPI-linked). The higher the increase you choose, the lower your starting income will be. You’re locked in at today’s interest rates for the rest of your life (annuity rates go up and down with interest rates, although this could be an advantage when annuity rates are high).

How it works in more detail

Different ways of receiving your income

Annuity payments from a conventional annuity can either continue as level or go up by a fixed amount each year.

What does a level payment mean?

The basic annuity you can arrange is one that will pay you the same amount of income every year throughout your retirement. It never goes down and it never goes up.

At first this may sound like a good idea, and certainly a level annuity will often give you the highest starting income of any of the retirement income products. But what about coping with increasing prices? With inflation, the purchasing power of your income will forever be decreasing.

What does an increase in payment mean?

There are steps you can take to protect your income at least partially from inflation. You can choose to have guaranteed increases (also known as ‘escalation’) built into your annuity each year, although this will mean a reduction in your starting income.

Depending on the type of pension you have now, you may be able to choose any increase from 0.1% up to 8.5% a year (subject to HM Revenue & Customs (previously known as Inland Revenue) restrictions). The more common increases are 3% and 5% per annum.

This increase is guaranteed throughout your retirement. It will never fall. But the higher the rate of increase you choose when you buy your annuity, the more your initial income will be reduced. Although your chosen rate of increase may not protect you fully from the effects of inflation, you’ll have better protection than if you had no increase at all.

The best protection against inflation is to have the annuity income RPI-linked, meaning it goes up each year in line with the changing Retail Prices Index. However, this may protect against inflation, but it is expensive, meaning that a much lower initial income will be payable. See inflation proof annuity for details.

Other types of annuities

You might wish to consider some alternatives

Other annuity types, such as an enhanced annuity and an impaired life annuity operate in much the same way but offer higher annuity rates for those that suffer from ill health and for who smokers. See the annuity guide page for further information about your choice of annuities.