What's an annuity and should you buy one?


   5 min read

An annuity is a financial product you can buy with your pension savings that will guarantee a fixed, regular income for the rest of your life. You might think of this as your pension income.

If you’re thinking about buying an annuity to provide you with secure income in your retirement, it’s important to know the basics. That's why we’ve put together an expert guide revealing what a pension annuity is, how it’s calculated, what to think about before buying one, and how you can get the best rates.

The term 'annuity' can seem daunting at first, especially when it's interchanged with other terms like 'pension annuity', or 'secure income'. You might find our pensions glossary helpful if you're unsure of any of the terms used.

Annuity meaning: what's an annuity income?

There are a number of ways you can use your pension savings once you reach the age of 55 (this will increase to age 57 from 6 April 2028). The option, or range of options, you choose really depends on your own personal needs when the time comes.

If you're looking for a regular, fixed income, buying an annuity might be the right option for you. You could use all, or just some, of your pension savings to buy an annuity, choosing to receive the income either for the rest of your life (lifetime annuity), or for a set period of time (fixed-term annuity). Pension annuities might be useful if you want to rely on a particular level of income because they might be able to provide that stability. While taking the same level of income might feel reassuring, the effects of inflation could reduce the buying power of that income over time if inflation increases.

Expert tip: It’s important to know that after buying an annuity, you can’t change your mind - which could prove difficult if your circumstances change.

Graphic showing a total pension pot divided into two elements: 25% tax-free cash and buying an annuity.. This image is an infographic and has alternative text available if you are using a screen reader.

Graphic showing a total pension pot divided into two elements: 25% tax-free cash and buying an annuity.

Types of annuity

Annuities have earned a reputation for being inflexible but there are many different types, different features available - each designed to add flexibility.

 As well as fixed-term and enhanced annuities which only provide an income for the pension owner, you can also buy joint-life annuities. These allow your spouse to carry on receiving an income after you die. You can also get inflation-linked annuities, which adjust your income on an ongoing basis to keep pace with prices. 

Adding and removing features might alter the income you receive so we strongly recommend speaking to a financial adviser before making any decisions. (An adviser may charge for their services – though they should agree any fees with you upfront.)

Once you’ve used your pensions savings to buy an annuity, you can't usually change your mind - even if your circumstances do. So, it’s really important you get things right first time. Our guide to your retirement options might help you to decide.

And, if you don't think an annuity is for you, there are other retirement options you could consider.

1. Lifetime annuity

A lifetime annuity pays a guaranteed regular income until you die.  The amount you're paid is determined by how much you invest, as well as your age and general health.

2. Fixed-term annuity

Fixed-term annuities (also known as certain-term or short-term annuities) pay you a regular income for a set period of time. The rest of your pension will be left invested, and once the fixed term ends, you'll need to decide what to do with the rest of your pension savings. This could include taking a lump sum or buying a further income.

3. Enhanced annuity

An enhanced annuity takes your health and lifestyle into account when working out the income you’ll receive if you have a long-term illness or medical condition, smoke or are overweight you may be able to boost the income you receive. This is because enhanced pension annuity rates are generally better than other annuities.

4. Joint-life annuity

This type of annuity is designed to continue paying your spouse or another beneficiary some or all the income you were receiving, after you die. It can be useful if your beneficiary doesn’t have much in the way of retirement provisions of their own.

5. Inflation-linked annuity

Inflation-linked annuities adjust your regular yearly income to keep pace with inflation (sometimes known as an RPI annuity because they track the retail price index). To begin with, the money you receive (your annuity payments) can be much lower than if you'd chosen a level or fixed-term annuity.

We hope you're going to enjoy a long and happy retirement so when it comes to something as important as your pension, you may want to speak to a financial adviser. They may charge for their services – though they should agree any fees with you upfront.

How is an annuity calculated and how much does it cost?

The exact cost will depend on the product you buy and your own personal circumstances. There are a number of factors used to calculate annuity prices and incomes. These include:

  • Interest rates: interest rates are a key factor in determining the annuity rates that providers can offer. Interest rates affect the income that an annuity provides, so a higher interest rate generally means a greater income
  • Life expectancy: how much income you get depends, in part, on the average length of time the provider expects to pay it out. The older you are when your secure income starts, the shorter that period is likely to be and so the bigger the income you could get
  • Health status: you may be offered a higher level of income, known as an enhanced annuity, if you have any health issues or habits, like smoking, which could shorten your life expectancy.
There are many different factors that can affect the way in which an annuity is calculated.. This image is an infographic and has alternative text available if you are using a screen reader.

Graphics displaying how different factors can affect the way in which an annuity is calculated.

  • Interest rates affect the income that an annuity provides - a higher interest rate = greater income.
  • Life expectancy is another factor. If people live longer, their monthly income will be lower.
  • Health conditions are a consideration too - people with health issues that could shorten their life may get a higher level of income.

Should I buy an annuity?

Buying an annuity isn't for everyone. It could offer you some reassurance because you'll know the amount of money you'll receive, and how long that money will last. However, it might not offer the flexibility of other products that might suit your circumstances better.

Buying an annuity is a big decision and not one that should be entered into lightly. This is because you can't usually change your mind once you have bought an annuity. It can be a good idea to seek professional advice before making changes to your pension because financial decisions often need careful management.

A summary

Benefits and features:

  1. Guaranteed income for life - your money won't run out. However, it can go down, but only in limited circumstances, for example, where varied in line with an index.
  2. Sense of security and income confidence - know exactly how much you'll receive each time you receive your pension income
  3. Support beneficiaries or loved ones - continuing annuity or the payments
  4. Up to 25% tax-free - you can usually take up to 25% of your pension tax-free before buying an annuity
  5. Income options to suit you – whether you prefer a fixed or increasing income, monthly or yearly, you have control
  6. Higher income - enhanced annuities can offer higher payments if you’re in poor health.

Things to consider:

  1. No going back - you can’t make any changes or get the pension lump sum back once your annuity has started
  2. You may get less back than you paid in – some fixed-term annuities only pay an income when you’re alive, so you may get back less than you paid in
  3. Income tax – depending on your circumstances, the money you get from an annuity could be taxable
  4. No cash-in or surrender value if your circumstances change
  5. Incorrect information may change your income - for enhanced annuities, inaccurate health details which don’t match your application could result in lower payments.

Best annuity rates

Shop around! There are lots of annuity providers out there, so it’s best to do your research to find the right one for you. Tell your pension provider when you plan to retire – they should then let you know how much money you have saved. You can then use this information to get a quote from as many providers as you need to.

It’s important not to just accept the first quote given. Shopping around for an annuity is known as exercising your ‘Open Market Option’ and it’s extremely important. There are a number of annuity comparison tools out there, such as the one offered by MoneyHelper.

We also have an annuity bureau service that lets you get quotes from a range of annuity providers to find the best current annuity rates. And, if you need further support, we strongly recommend speaking to a financial adviser. An adviser may charge for their services – though they should agree any fees with you upfront.

Expert tip: If you have more than one pension pot, it might be worth consolidating them into one larger pot. It’s very important that you speak to a financial adviser before doing this. An adviser may charge for their services – though they should agree any fees with you upfront.

Frequently asked annuity questions

When the annuity holder dies, the remaining funds won’t return to the provider or anyone else – unless you have a guarantee or a joint life annuity. The money is effectively lost as you used your pension savings to buy the annuity. 

Currently, you have to be at least age 55 to purchase an annuity. However, you can take an annuity earlier if you have a protected pension age or are in ill heath.

Whether you should buy an annuity will depend on your needs. Consider things like how early you want to retire, how long you expect to live and how much income you might need per month.

You may be able to borrow money from your pension annuity, but be aware that  it’s likely that you’ll have to pay early withdrawal fees or a ‘surrender charge’.

If you want to find out more about annuity and your retirement options, speak to a financial adviser for personalised advice and recommendations. You can also find out more about our pension schemes and how to invest your savings.