What is an annuity?

An annuity is essentially a financial contract where the provider, in return for a sum of money paid now, will guarantee the annuity-holder a fixed income for the rest of their life, usually paid monthly. This has made annuities especially suitable as a form of pension provision.

Key takeaways:

Annuities are a type of financial product that provide a guaranteed income for life or for a fixed period of time.
Annuities are typically purchased from insurance companies or investment managers.
There are different types of annuities, including fixed annuities, variable annuities, indexed annuities, and immediate annuities.
Annuities can be a good option for people who want to ensure a steady income stream during retirement, but they may not be suitable for everyone.

Where have you heard about annuities?

No discussion of long-term savings or retirement planning is complete without a mention of annuities, which have played their key role in this area for more than 100 years. Personal-finance broadcasts and publications will discuss annuity rates and say which providers give the best deals, as well as suggesting alternatives to annuities.

What you need to know about annuities

Some annuities take contributions during your working life and then pay out after retirement; others are bought on retirement with the pension pot you've accumulated over your working life. Either way, the principle is the same: in return for money now, the provider usually an insurance company or investment manager – will pay the annuity-holder an income for however long they live.

The value of the annuity for which the savings are exchanged on retirement is known as the annuity rate. The generally low returns on investments since the Millennium have recently fuelled criticism of meagre annuity rates.

Fixed annuities pay out a set sum, rather like a bank savings account. Variable annuities behave more like an investment fund, paying out in line with the performance of securities in which it is invested.