Guide to Annuities
UK Pensions

Types of Annuities

There are two types of annuity policy available in the UK, these are:

The main difference between voluntary and compulsory purchase annuities is voluntary purchase annuities are bought with personal savings (not pension scheme savings) or a capital lump sum, there are also tax differences. The capital lump sum used to buy a voluntary annuity can be the 25% tax free cash lump sum you are allowed to take from your pension fund.

Compulsory purchase annuities are bought with pension funds, everyone who has a private (non-state) pension scheme was, until recently, required by the Government to buy a compulsory annuity with at least 75% of their pension fund (allowing for 25% to be taken as a cash free lump sum), as at June 2010 the Government is phasing this requirement out. These are called pension or retirement annuities.

Voluntary purchase annuities can offer an alternative to putting your savings into a bank or building society. Putting your savings into a bank account means you can earn interest and you get your full savings amount back from the Bank when you die or close the account. However, the amount of interest earned is affected by rising and falling interest rates.

Using your savings to buy a voluntary annuity can provide a higher income than bank interest payments would, but you don't get your initial savings amount back if you die or when the annuity term ends. However, you are guaranteed a certain level of income which is not affected by rising or falling interest rates.

A voluntary annuity can be a good option for people who don't need to have a lump sum left in the bank when they die, and want to use their savings to 'buy' an income to use while they are alive. It is always essential though to consider other investment options which also generate income, such as investment bonds, ISAs and some National Savings products, before taking out a voluntary purchase annuity.

The table below outlines the types of voluntary purchase annuities available in the UK:

Voluntary Purchase Annuity Type How it works
Purchased Life Annuity Also known as an Immediate Life Annuity, it pays a regular, guaranteed income for either:

  • the rest of your life, or
  • for a fixed period of between 2 and 20 years (temporary annuity).
Taxed differently to pension annuities, income is made up of a 'capital' part and an 'interest' part. The capital part is treated as a return of your capital and is therefore not taxed.

Similar annuity income options are available as for pension annuities. No age limit to buy, anyone of any age can have one. Minimum amount required to buy is around £5,000. Maximum investment amount around £500,000.

Immediate Vesting Annuity Can also be known as an Immediate Life Annuity, it pays a regular, guaranteed income like a purchased life annuity but can be purchased from either:

  • accumulated savings, or
  • a pension fund.
Must be aged 55 years or older to purchase. Taxed differently to purchased life annuities. Provided you are over 55 and a UK resident, you are entitled to up to £720 in tax relief and an immediate tax free lump sum. For example, if you contribute £2,880 to an immediate vesting annuity, you receive £720 in tax relief, bringing the contribution amount up to £3,600. Of this, 25% is paid back to you in the form of a tax free lump sum of £900. The remainder of the fund goes to purchase the annuity.

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Guide Contents

What is an Annuity?
When might I need an annuity policy?
Types of Annuities
Pension annuities
Annuity income options
Enhanced and Lifestyle Annuities
Impaired Life Annuities
Annuity Rates
Where can I go to get more help?

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