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If you have a defined contribution pension (also known as a money purchase pension), you can decide to convert some, or all of your pension pot into an annuity. An annuity is a guaranteed lifetime income that you buy when you retire. You can buy your annuity from the age of 55 and the income you get is based on mathematical life expectancy models that take into account factors such as your age, gender, where you live, lifestyle and medical history. The older you are when you start your annuity, the higher your monthly income will be. If you have a bad lifestyle habit, such as smoking, or you haven’t been in the best health, you might be eligible for an enhanced annuity. An enhanced annuity can provide a greater monthly income for you in retirement.
The downside to an annuity is that if you pass away relatively soon after retirement, you may not have received as much in income as was in the pension pot you used to buy it. You might think that this entitles your family to any remaining money; however, this is not the case. To be sure of your family getting at least some financial legacy if you die prematurely, you could take out a ‘guaranteed’ annuity. This would continue to pay annuity income to your estate if you die within a set period of the annuity starting (normally annuity guarantee periods are offered over five or ten years). Alternatively, you could opt for something called 'Value Protection' when you take out your annuity. This means that unused money from your pension pot can be returned to your estate.
Another option is to get a joint annuity with your spouse or partner that continues to pay the full amount or a reduced amount after the first person dies. Depending on how old your partner is compared to you, these may pay less than a single annuity, especially if the annuity provider expects to be paying the income for longer where your partner is younger or healthier than yourself.
Some pensions, mainly older ones, offer what is called a Guaranteed Annuity Rate (GAR). As life expectancies increase, annuity incomes have fallen dramatically, so chances are that the GAR your pension provider offers is the best income you can get. Nevertheless it is never more important to shop around than with an annuity as once you make that choice; you are bound by that decision for the rest of your life.
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