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 - also known as secure income.
Annuities are a big commitment, as you can’t change your mind once you buy one. That’s why it’s important to understand how annuities work, the different types of annuities that are available, and the kind of features and benefits they could offer.
Annuities explained
You can use the money in your pension to buy an annuity. This will give you a fixed, regular income for the rest of your life. You can choose to receive your income monthly, quarterly, every six months or yearly.
The amount you’ll receive depends on how much you’ve saved in your pension, your age and health when you retire, as well as any features you want to add on.
It’s important to think about whether your regular income will be enough to afford the kind of lifestyle you want in retirement. While you’ll have the stability of a regular income, inflation and the rising cost of living could affect how far your money goes.
How to buy an annuity
Like other methods of taking money from your pension plan, you can only buy an annuity once you reach the age of 55 (rising to 57 from 6 April 2028). You can buy an annuity earlier if you have a protected pension age or if you’re in poor health.
Our guide to taking money from your pension can help you understand your options, so you can decide if an annuity is the best choice for your needs.
You don’t have to use all your pension savings to buy an annuity. For example, you could take a cash lump sum from your pension and use the rest to buy an annuity. You can also combine different retirement income options, like using some of your pension to buy an annuity and keeping the rest in drawdown. You can also be in drawdown and then choose to buy an annuity with some of your drawdown pot.
Also, you can choose whether you want to receive a regular income for the rest of your life (a lifetime annuity) or for a set amount of time (a fixed-term annuity).
Before you decide
Remember that you can’t change your mind after buying an annuity, even if your circumstances change. Our retirement planning guide can help you to plan the kind of lifestyle you’d like in retirement, and how much you’ll need to save to afford it.
Types of annuities explained
Annuities have a reputation for not being very flexible. This isn’t always the case, as it depends on the type you choose and the features it offers.
Lifetime annuity
A lifetime annuity pays a guaranteed regular income until you die. The amount you're paid is determined by how much you’ve saved over the years, as well as your age and general health.
Fixed-term annuity
Fixed-term annuities (also known as certain-term or short-term annuities) pay you a regular income for a set period and can be bought with a portion of your pension. Whatever is left in your pension stays invested.
This means that once the fixed term ends, you’ll get to decide what to do with the rest of your pension. You could take a cash lump sum or buy more regular income – it’s up to you.
Enhanced annuity
An enhanced annuity takes your health and lifestyle into account when working out the income you’ll receive. This is because people with shorter life expectancies don’t need to make their pension savings last as long.
You may qualify for an enhanced annuity if you:
- Have a long-term illness
- Have a serious medical condition
- Smoke
- Are overweight.
Joint-life annuity
A joint-life annuity keeps paying out to a nominated person (also known as a beneficiary) after you die. This could be a good option if your partner hasn’t saved much into their own pension, or if you have children that are still dependent on you.
You’ll need to choose who the money goes to.
From April 2027, unused pensions will be subject to inheritance tax unless they’re left to a husband, wife or civil partner. This means an unmarried partner could have to pay inheritance tax. However, if a joint-life annuity is set up by a cohabiting couple, there will be no inheritance tax to pay when the first person dies.
Inflation-linked annuity (Escalating)
Inflation-linked annuities adjust your yearly regular income to keep pace with inflation. These are sometimes known as RPI annuities because they track the Retail Price Index. It may also be possible for annuities to increase by a set percentage each year.
At first, the income you receive from an inflation-linked and escalating annuity can be far lower than a regular or fixed-term annuity.
Inflation and your annuity
A non-inflation-linked annuity pays a fixed income for life. As the cost of living rises, that income may not go as far as it would today.
Investment-linked and with-profit annuities
With these types of annuity, your regular income goes up and down in line with the performance of investments, such as stocks and shares.
Guaranteed and value protected annuities
You can guarantee your annuity for a set number of years – usually up to 30 years. This means that if you die during that period, payments will transfer to your nominated beneficiary.
A value protected annuity helps ensure that, if you die early, some of your pension money isn't lost. If the total income paid out is less than the protected amount chosen, the remaining value can be paid as a lump sum to your beneficiaries. If someone who is not a husband, wife or civil partner receives money from a guarantee period of value protected annuity, it may be subject to inheritance tax.
Should I buy an annuity?
As mentioned previously, annuities can't be changed after you've bought one. They're a big decision, so it's wise to speak to a financial adviser before proceeding. Advisers may charge for their services but they should agree any fees with you upfront.
Annuity benefits and features
It’s important to understand the features and benefits of your chosen type of annuity. There are some standard features and additional benefits you should know about to help you decide.
- Guaranteed income for life. Your money won't run out, although it may go down if you’ve chosen an investment-linked or with-profit annuity.
- Sense of security and income confidence. You’ll know exactly how much money you'll get each time you receive your pension income – whether that’s monthly, quarterly, every six months or yearly.
- Support your beneficiaries. Guaranteeing your annuity or taking out a joint-life policy means your loved ones will still receive an income when you’re gone.
- Up to 25% tax-free. In most cases, you can take up to 25% of your pension as a tax-free cash lump sum before buying an annuity.
- Income options to suit you. Whether you prefer a fixed or increasing income, monthly or yearly payments, you have control.
- Higher income if you’re in poor health. Enhanced annuities can offer higher payments to those with certain lifestyles or medical conditions.
What to consider before buying an annuity
You can’t make changes to an annuity after you’ve bought it, so it’s important to weigh up your decision with these considerations:
- There’s no going back. You can’t make any changes or get your pension lump sum back once your annuity has started.
- You may get less back than you paid in. Some annuities only pay an income when you’re alive, so you won’t get all of your money back if you die early in retirement.
- You may need to pay income tax. Depending on your circumstances, the money you get from an annuity could be taxable.
- No cash-in or surrender value if your circumstances change.
- Incorrect information may change your income. For example, enhanced annuities may lower your payments if you give the wrong health details on your application form.
Frequently asked annuity questions
How is an annuity calculated and how much does it cost?
When working out how much income to offer, annuity providers consider a number of factors, including:
- Interest rates: higher interest rates generally mean providers can offer a higher income.
- Your age: in general, the older you are when you buy an annuity, the higher the income you may receive.
- Life expectancy: providers estimate how long they may need to pay your annuity for.
- Health and lifestyle: some medical conditions or lifestyle factors may qualify you for an enhanced annuity, which could provide a higher income.
- Where you live: some providers take location into account as part of their assessment of life expectancy.
How often will I receive annuity payments?
You can choose how often you want your income to be paid – monthly, quarterly, every six months or yearly. You can also ask for your income to be paid as soon as possible (in advance) or at the end of your chosen payment frequency (in arrears).
What are the best annuity rates?
There are lots of annuity providers out there, so it's worth getting a quote from as many as possible. You might need some information from your pension provider to do this. Tell them when you plan to retire, and they’ll tell you how much money you have saved. You can use this data when you speak to annuity providers.
Don’t feel pressured into accepting the first quote. Shopping around for an annuity is known as exercising your ‘Open Market Option’. You can use a comparison tool to find the best annuity rates, or our annuity bureau service.
What happens to an annuity when you die?
That depends. If you have a guaranteed, value protected or joint-life policy, the income will go to your nominated beneficiary. Otherwise, the remaining funds won’t be returned to your family, your pension provider or anyone else. The money is effectively lost. This is because an annuity is a product you choose to buy with your pension savings, it’s not the savings themselves.
When should you buy an annuity?
It depends on your needs. Think about how early you want to retire, how long you expect to live and how much income you’ll need per month.
