For many of us, coming to the end of our working life is a daunting prospect, and one of the most tricky obstacles to negotiate when that time comes is managing finances in the absence of a salaried income. Annuities are now a big part of pension management in the UK, and it's important you acquaint yourself with the ins and outs of how they work.
What is annuity?
First things first, an annuity is essentially a retirement fund that is dripped into your pot at a fixed amount per year. You pay your pension savings to a host company, and it accumulates interest over the years, giving you an overall greater share of the spoils - albeit over a much longer period.
Annuities are bought from private insurance companies, independent of state pensions (which comes with a few warning labels, which we'll get to later). They are by no means a prerequisite for retirees, many preferring to use their pension money to fund a dream holiday or a house in the countryside, but most agree it's the sensible and sustainable way to settle down after giving up full-time work.
How are they calculated?
The most important tip we can give is to make sure you seek personalised, impartial advice from your local financial advisors (that means people who have your best interests at heart, instead of those looking to pad out their profit margins).
Many factors can go into calculating annuity, the most important of which being your life expectancy - as this, difficult though it is to think about, dictates how much companies anticipate you taking out of your pot over the duration of your custom with them.
This means things like whether you're a smoker and if you have any hereditary conditions in the family will play a big factor in the type of annuity you get (and it's this information that you'll need to hand when you apply for an annuity).
Generally, the lower your life expectancy, the higher your yearly payments and interest rates will be - simply because there's ultimately fewer years in which companies expect to have to pay out.
Most people tend to get into the habit of sticking with the insurance companies they've come to trust over the years - but the government and independent regulators both strongly encourage you shop around to try and find a better deal. Rates do vary from company to company, and you need to consider how much you'll be paying in at the outset, and what kind of living costs you need in the short-term.
Ultimately, choosing your annuity is one of the biggest decisions you'll make towards the end of your life, and the shady insurance world is there to take advantage of your mistakes - so it's important to understand your consumer rights as well.
The good news is schemes are being introduced which mandate insurance companies to let their customers know which of their competitors will offer a better deal than they will. This doesn't negate the importance of taking independent advice, but it does mean you are a little more protected in the event you are missold your annuity.