Annuities are the main way of turning a pot of cash into an income stream. In very simple terms, they work like a life insurance policy in reverse–you pay them a lump sum up front, then they pay you regularly until you die.
There are two specific types of risk with annuities. The first is the risk that you die early and, thus, don’t receive as much money back as you paid up front.
The second risk only applies to some forms of annuities. You can get annuities that pay a fixed amount, often based on factors such as your age, gender and health status when you buy the annuity. However, you can also get variable annuities in which the insurer invests the money, meaning the amount you receive depends on the performance of the investments. To mitigate this risk, you can opt for the middle-ground of an index-linked annuity.
Whether annuities are right for you and what level of risk is appropriate will depend on your financial circumstances. You’ll also need to carefully consider the tax implications, particularly if you want to retire early.