Your annuity questions

An annuity - also called a pension annuity - guarantees to provide you with a regular income for the rest of your life, in return for you paying over a lump sum from your pension fund to an annuity provider. The income is intended to take over from your earnings when you retire, but you can continue working and still have an annuity if you choose. You can also defer buying an annuity when you retire and keep your money invested, but you must normally purchase one before you turn 75.

There are a number of different ways to take an income from your pension fund. Within our annuities guide we have highlighted some of the benefits and things to consider for the most popular types of annuity, including a conventional annuity with level income, conventional annuity with changing income, with-profits annuity such as our Income Choice Annuity and unit-linked annuity.

If you have an illness, condition or a lifestyle habit such as smoking that may shorten your life, you may qualify for an 'enhanced' or 'impaired life' annuity. This normally pays a higher income. (Our Guaranteed and Income Choice Annuities are all available on enhanced terms).

The Retail Prices Index or RPI is a monthly indication of the average price changes to a particular 'basket' of consumer goods, and is used as a general indicator of price inflation. Some types of annuity are linked to the RPI with the aim of keeping pace with inflation. (Your income changes in line with the index). However if you choose this type of annuity and inflation is negative, your income may go down (unless you choose to protect against this).

You don't always have to buy an annuity when you reach the retirement age shown on your pension plan. You may be able to continue working full or part-time and make extra payments into your pension pot, or you can just leave your fund invested while you make a decision. On 6 April 2010, the minimum retirement age rose from 50 to 55. You don't normally have to stop working to take income from your pension. However if you decide to take any tax-free cash, you must do so before you turn 75 and at the point you take out your annuity.

The Open Market Option means you are free to shop around and choose who you purchase your annuity from. Annuity rates can vary considerably between providers and, even with one provider, the rates can differ according to the annuity options you choose. The top provider for one set of options may not come out on top for another set.

The main reason is that not all providers would give you the same benefits in return for your pension savings. The difference in benefits can be quite significant between the best and worst providers on the market. Also not all providers are specialists and don't offer a range of annuity options. It is important to note that in most cases, once you have purchased an annuity, you can't change your mind.

This depends - if the total of all your pension funds is less than £18,000 (for the 2010/11 tax year) then you can withdraw it all as cash. However, only 25% will be tax free, the remainder will be taxed as earned income under PAYE.

If the total value of all your pensions is more than £18,000 (for the 2010/11 tax year) then you must take an income with your pension fund. However with many pensions you can take up to 25% as a tax-free lump sum. (If taken this means you will receive about 25% less income when you purchase your annuity - after any fixed charges are taken into account.)

Although most people decide to take a tax-free cash sum from their pension fund up front, you don't have to. You could keep it invested and use it to buy a larger retirement income. However this may not be the most tax-efficient way to provide any extra cash flow you need, as the income payable through a personal pension or annuity is taxed. You can only elect to have the tax-free cash when you choose your annuity option - it cannot be opted for once the annuity is in payment, or if you are 75 or older.

An option might be to consider using your tax-free cash sum to secure what is known as a purchased life annuity where only a part of the income is taxable. Your financial adviser can help you with this.

You don't have to buy an annuity as soon as you retire. 'Income drawdown' enables you to keep your money invested in your pension fund and take out an income in the meantime. There is a maximum amount of income that you will be able to take depending on your age and fund value.

Income drawdown enables you to invest your money in a range of funds and you can move your money around if you want to. However, if these funds perform badly, and/or you take too high an income, your pension fund will be reduced. Annuity rates may also fall by the time you want to buy one. Income drawdown is more complicated and is riskier than buying an annuity, so you might find it helpful to discuss with a financial adviser. (There may be a charge for financial advice.)

Once set up, the majority of annuities cannot be changed in any way. This is why it is important to shop around and select the right annuity for you. Please see the Open Market Option question above.

You may be able to combine your different pensions into one overall fund to maximise the type of annuity you can buy. This will depend on the pension scheme you have, so when getting annuity quotations, ask if you're able to combine your various funds.

You can save in a company or personal pension at the same time and there is no limit on the number of schemes you can invest in. However there is a maximum amount that your combined pension pots can be worth without an additional tax charge. This is known as the 'lifetime allowance' and for the 2010/11 tax year the limit is £1.8 million.

The government believe that you're only likely to be impacted by the lifetime allowance if your yearly earnings were more than £70,000 or if you retire under the age of 40. If you think your pension savings are likely to be affected, your financial adviser will be able to give you more information and advise you on your best course of action.

'Recycling' is where a tax-free cash lump sum is withdrawn from a pension plan and then some or all of the money is re-invested into the same or another pension plan. This recycled contribution would then get tax relief as any normal contribution would do.

Since 6 April 2006, the government has put a restriction on this to prevent people getting tax relief on both the contributions they made to their pension plan, and the money they re-invested. With many pensions you can take up to 25% of your fund as a tax-free lump sum. The tax-free cash recycling rules apply if the amount taken is more than 1% of the lifetime allowance. For the 2010/11 tax year, the lifetime allowance is £1.8 million.

Restrictions also apply if the additional contribution exceeds 30% of the tax-free cash sum taken, and the recycled contribution results in contributions to all pension plans being 'significantly increased'. A significant increase is where:

• the total tax-free cash you receive in the 12-month period (ending on the day the tax-free cash is paid) exceeds 1% of the standard lifetime allowance, and
• more than 30% of those tax-free cash sums is used to make contributions (either directly, indirectly or by someone making contributions on your behalf, such as your employer) to one or more registered pension schemes over and above the expected level of contributions. This includes any contributions you may have made in anticipation of receiving the tax-free cash.

Your income will be paid in regular instalments. You can normally choose to be paid monthly, quarterly, half-yearly or yearly, and in advance or in arrears. Whatever the frequency, you'll get the highest income if you can be paid in arrears (at the end of the period).

Annuity income payments are treated the same way as income you earn while working when it comes to tax. If you are a United Kingdom basic rate taxpayer, you will be taxed at the rate of 20% on your annuity income for the tax year to April 5, 2011, subject to your personal allowance. (In the tax year 2010/11 everyone up to age 65 has a personal allowance of £6,475, rising to £9,490 between the ages of 65 and 74 and £9,640 at 75 and over. This means you can earn this amount without paying tax.) If you pay income tax at the higher rate you may be liable for tax on your pension income at the higher rate.

Your wife/husband/civil partner should continue to receive payments after you die if you purchase your annuity on 'joint-life' terms.

In addition to being able to purchase an annuity on joint-life terms, you could also choose a guaranteed payment period. This means that your annuity will be paid for a minimum number of years even if you die. With this option you will receive a lower starting income than an annuity without a guaranteed payment period. Your pension annuity income can be set up with a guaranteed term of up to 10 years, or five years for Protected Rights (see below).

If you're employed you can normally contract out of the State Second Pension. One option is to contract out using a personal pension or stakeholder pension. This means that you give up your right to benefit from State Second Pension for the period you are contracted out. As a result, your State Second Pension benefit will be reduced. In return, HM Revenue & Customs sends your selected pension provider a rebate of part of your own and your employer's National Insurance contributions. These are invested in your plan and the fund that this produces is called 'Protected Rights'.

There are special rules about the benefits you can get from Protected Rights and when they can be taken. If you are married or have a civil partner for instance, you must choose a joint-life annuity for this portion of your pension. As you near your retirement date your scheme provider will send out a quotation that highlights any rules that apply.