What Is an Annuity?

After years, sometimes decades, of paying into a pension pot, you eventually reach the point where you need to turn those savings into money you can actually spend. An annuity is one of the two main routes for doing that (the other being drawdown), and it works completely differently: rather than keeping your pot invested and drawing from it as needed, you hand some or all of it to an insurance company in exchange for a guaranteed income that is paid to you for the rest of your life, however long that turns out to be. This page explains exactly what an annuity is, why so many retirees still value them even in an age of flexible drawdown, the main varieties on offer, how insurers work out the rate they'll offer you, and the one big trade-off you need to understand before you buy one.

An annuity in plain English

Strip away the jargon and an annuity is simply a swap. You give an insurance company a lump sum, usually some or all of your pension pot, and in return it promises to pay you a fixed income at regular intervals, typically monthly, for as long as you live. It is, in effect, a bet on your own longevity that the insurer is willing to take the other side of. If you live to 100, the insurer keeps paying. If you die the year after buying it, the insurer has, in most cases, done very well out of the deal, because a standard annuity with no guarantee period simply stops paying when you die and nothing passes to your estate. That trade-off, certainty for you in exchange for the insurer pooling longevity risk across thousands of customers, is the entire logic of how annuities work, and it explains both why people like them and why they can feel like poor value if you happen to die early.

Why people value the certainty

The appeal of an annuity is almost entirely about what it removes from your life, rather than what it adds. Once you've bought one, you no longer have to think about stock market performance, interest rates, or how quickly you're withdrawing money relative to how your investments are performing. There is no danger of running out of money in your nineties because you drew down too aggressively in your sixties and seventies. There is no monthly decision to make about how much to take out, and no need to keep track of investment statements or worry about a market crash arriving at exactly the wrong moment. For many retirees, particularly those who dislike financial uncertainty or who simply want retirement income to work like a salary always did, that peace of mind is worth a great deal. An annuity converts a variable, sometimes worrying, pot of money into something that behaves like a very reliable pension payslip landing in your bank account every month, for the rest of your life, no matter what happens to markets, interest rates, or the wider economy.

The main types of annuity

Not all annuities are the same, and the choices you make when you buy one have a big effect on both the income you receive and what happens to that income over time or after you die. The main variables are whether the annuity covers one life or two, whether the income stays flat or rises over time, and whether a minimum payment period is built in regardless of when you die. The table below summarises the main options.

Single life versus joint life

A single life annuity pays an income for as long as you, the person who bought it, are alive, and then it stops completely, with nothing passing to anyone else. A joint life annuity, by contrast, is built around two people: when you die, a proportion of the income, commonly 50% or 66% but sometimes 100%, continues to be paid to a named survivor, usually a spouse or civil partner, for the rest of their life too. Because the insurer expects to be paying out over two lifetimes rather than one, joint life annuities start at a noticeably lower income than single life annuities bought with the same size pot. Anyone with a financially dependent partner should think very carefully before choosing single life purely to maximise their own starting income, since it can leave a surviving partner with a sudden and permanent drop in household income. We cover this decision in much more detail on our dedicated joint life annuity page.

Level versus increasing income

A level annuity pays the same cash amount every year for the rest of your life. It starts higher than an increasing annuity bought with the same pot, which makes it attractive if you want to maximise your income in the earlier, typically more active years of retirement. The catch is that inflation gradually erodes its real spending power: a level income of, say, £12,000 a year will buy noticeably less in twenty years' time than it does today, even at relatively modest inflation rates. An increasing or inflation-linked annuity starts lower but rises each year, either by a fixed percentage you choose upfront (commonly 3% or 5%) or in line with an inflation measure such as the Consumer Prices Index. Over a long retirement, an increasing annuity can end up paying substantially more in total, and it protects your purchasing power, but you have to accept a lower income in the early years to get there.

Guaranteed periods

One of the biggest emotional objections to annuities is the fear of "dying too soon" and losing most of the pot to the insurer. A guaranteed period addresses this directly: you choose a minimum period, commonly five or ten years, during which the annuity will keep paying out even if you die, with the remaining guaranteed payments going to your estate or named beneficiary. If you live beyond the guarantee period, it simply makes no difference at all; the income continues as normal for the rest of your life. Adding a guarantee period costs very little in terms of reduced starting income compared with the peace of mind it buys, which is why many advisers consider at least a five-year guarantee a sensible, low-cost addition for most people rather than an optional extra.

How the rate you're offered is calculated

The income an insurer offers you for a given pot size, known as the annuity rate, depends on several factors working together. Your age matters enormously: the older you are when you buy an annuity, the higher the rate, because the insurer statistically expects to pay out for fewer years. Your health and lifestyle matter too; conditions or habits that are statistically associated with a shorter life expectancy can significantly increase the rate you're offered, through what's known as an enhanced or impaired life annuity, which we cover in detail on its own page. The features you choose also affect the rate directly, as set out above: single life pays more than joint life, level pays more than increasing, and no guarantee period pays marginally more than one with a guarantee attached. Finally, and often overlooked, prevailing interest rates and gilt yields have a huge effect on annuity rates generally, because insurers largely back annuity promises with government and corporate bonds. When gilt yields are low, as they were through much of the 2010s, annuity rates are poor across the board; when gilt yields rise, as they have done markedly since 2022, annuity rates improve for everyone, regardless of their personal circumstances. Our dedicated annuity rates page goes into this history and what today's rates look like in more depth.

The key downside: it's usually irreversible

The single most important thing to understand about a standard annuity is that, once bought, it generally cannot be undone. There is no "cooling off" period beyond the standard initial reflection window most providers offer, and no option to change your mind five years later, cash it in, or switch provider if you find a better rate elsewhere. You are locking in the rate, the features, and the income structure you chose on day one, for the rest of your life. This is precisely why the decisions covered above, single versus joint life, level versus increasing, and whether to add a guarantee period, deserve serious thought before you commit, rather than being treated as small print to skim over. If you die relatively soon after buying a single life annuity with no guarantee period, the insurer keeps the remainder of what you paid in; there is no refund, no return of the unused pot, and nothing passes to your family unless you specifically bought features designed to provide for that possibility.

Is an annuity right for you?

There's no single right answer here; it depends heavily on your circumstances, your other sources of income, and how much you value certainty versus flexibility. An annuity tends to suit people who want a guaranteed baseline income to cover essential living costs, who are uncomfortable with investment risk in retirement, or who simply don't want the ongoing responsibility of managing a drawn-down pension pot into their eighties and nineties. It tends to suit people less well if they have a shorter-than-average life expectancy and no interest in enhanced rates or guarantee periods, if they want to leave a meaningful inheritance from their pension, or if they value the flexibility to vary how much they take out year to year. Many retirees, in practice, use a mixture of both: buying a modest annuity to guarantee the essentials, such as bills and food, while leaving the rest of their pot in drawdown for flexibility and growth potential. Our annuity versus drawdown page walks through that comparison, including the "hybrid" approach, in much more detail.

Why shopping around matters so much

One detail catches out more retirees than almost anything else in the annuity market: you are not obliged to buy an annuity from the company that has been looking after your pension pot for the last thirty years. This right is known as the "open market option," and using it can make a substantial difference to the income you end up with, because annuity rates vary noticeably from one provider to another for exactly the same person, the same pot size, and the same features. An insurer's rate depends on its own view of longevity, its appetite for new business at any given moment, and how it currently prices the risk it is taking on, which means the rate your existing pension provider quotes you is very rarely the best one available on the wider market. Working with a broker or adviser who compares quotes across the whole of the market, rather than accepting the first offer that lands on your doormat, is one of the simplest and most reliable ways to improve your retirement income without taking on any additional risk at all.

A simple worked example

Imagine two people, both aged 65, each with a pension pot of £100,000. The first buys a single life, level annuity with no guarantee period, and might be offered an income in the region of £7,000 a year at current, broadly illustrative rates. The second wants to protect a partner and adds a joint life feature at 50%, alongside a five-year guarantee period, and might be offered something closer to £6,300 a year for exactly the same pot. Neither figure is a real quote, since actual rates depend on the insurer, the exact underwriting date, and your personal health and circumstances, but the comparison illustrates the general pattern: every extra feature you add for greater protection or flexibility is paid for through a slightly lower starting income, and it's worth deciding deliberately which features matter to you rather than defaulting to whichever quote arrives first.

Annuities and the rest of your retirement income

It's worth remembering that an annuity rarely needs to do all the work on its own. Most people retiring today will also receive the new State Pension, currently £230.25 a week for those with a full National Insurance record, which already provides a guaranteed inflation-linked income base. Many will also have other savings, workplace pensions from previous employers, or a spouse's income to factor in. Deciding how much of your own pot to convert into an annuity, rather than treating it as an all-or-nothing choice, is often the more useful question: you can annuitise a portion of your pot to cover essential costs alongside the State Pension, while leaving the remainder invested in drawdown for flexibility. This partial approach avoids locking away money you might want access to later, while still buying real peace of mind for the portion you do convert.