What Is a Pension Annuity?

What Is a Pension Annuity?

A pension annuity is the swap: you hand over some or all of your pension pot to an insurer, and they pay you a guaranteed income in return — either for the rest of your life, or for a fixed term. Simple in principle, with a lot of detail underneath.

Whether an annuity is right for you depends on what you actually need from your pension. Here's how they work and what to look out for.

The basic mechanics

You choose how much of your defined contribution pension pot to convert — it doesn't have to be all of it. You pick the shape of income you want. The money transfers to the insurer. They pay you the income under the terms you agreed.

The critical thing to understand before you go anywhere near one: once the cooling-off period ends (typically 30 days), the decision is permanent. You cannot hand the annuity back, change the terms, or access the underlying capital. The insurer takes on the risk of you living a very long time. In return, you give up flexibility for good.

That trade-off is not inherently good or bad. For plenty of people, certainty is exactly what they want. For others, the loss of flexibility is too high a price. For a full picture of all the ways you can take money from a pension — annuity, drawdown, lump sums — see the pension withdrawal guide.

The different types of annuity

The UK annuity market is effectively a menu of income shapes and optional protections. Adding features generally reduces your starting income, because the insurer expects to pay more over the life of the policy.

Lifetime annuity — pays a guaranteed income for however long you live. The insurer takes on longevity risk entirely. This is the most common type.

Fixed-term annuity — pays for an agreed period (typically between 1 and 40 years) and usually includes a "maturity amount" at the end, which you can use to buy another annuity or move into drawdown. Worth knowing: a fixed-term annuity triggers the Money Purchase Annual Allowance, which caps future pension contributions at £10,000 a year. A lifetime annuity does not.

Level annuity — the income stays the same every year. It typically starts higher than an increasing annuity, which is appealing, but it loses real value over time as prices rise. After 20 years of 3% inflation, £1,000 a month buys roughly half what it did at the start.

Inflation-linked / escalating annuity — rises each year, either at a fixed percentage (say 3% or 5%) or in line with RPI, sometimes with a cap. The starting income is lower — sometimes significantly — but the purchasing power holds up better over a long retirement. To give a sense of the trade-off: MoneyHelper's own illustration shows that a £200/month level annuity would still be £200 after 10 years, versus around £261 if it had been increasing at 3% a year.

Enhanced / impaired life annuity — pays more if your health or lifestyle means the insurer expects you to live a shorter-than-average life. Qualifying factors include conditions like diabetes, high blood pressure, cancer, and being a smoker. When Which? ran quotes in mid-2025, an enhanced rate for a 65-year-old with relevant health factors produced income uplifts of roughly 6% to 15% above the standard rate, depending on the provider. If you have any relevant health history, it almost always pays to disclose it fully and get an enhanced quote.

Joint-life annuity — continues paying a proportion of your income (often 50%, 66%, or 100%) to a spouse or named partner after you die. The initial income is lower because the insurer expects to pay for longer in total. If you have a partner who depends financially on you, this is usually worth considering seriously.

Investment-linked annuity — a lifetime annuity where income can vary with investment performance rather than being fully fixed. These exist but they are not mainstream. FCA data for 2024/25 shows around 80% of annuities sold were level, around 20% were escalating, and investment-linked variants represent a small fraction of the market.

What determines your annuity rate

Several things feed into the income figure a provider will quote you.

Interest rates and gilt yields. This is the biggest external driver. Insurers invest the premium you pay in long-term bonds — mainly government gilts — and the yield on those bonds determines how much income they can afford to pay. When gilt yields rise, annuity rates improve. The sharp rise in interest rates from 2021 onwards is why annuity rates in 2024/25 are considerably better than they were for most of the 2010s. By December 2025, a healthy 65-year-old with a £100,000 pot could secure around £7,510 a year from a standard single-life level annuity — a rate that would have looked very good against anything on offer between 2010 and 2020.

Your age. The older you are when you buy, the higher the starting income, because the insurer expects to pay for fewer years on average. There's no single "right" age to buy — it depends on your circumstances — but the rate improvement from waiting is not guaranteed if yields move the other way.

Your health and lifestyle. As described above, enhanced rates can be meaningful. Always answer health questions fully and accurately. Providers may ask for GP information in some cases.

The options you choose. Joint-life cover, inflation-linking, guarantee periods, and value protection all reduce the starting rate because they transfer more risk onto the insurer. Each addition is a cost-benefit decision: what certainty or protection does this buy me, and what does it cost in reduced income?

Which provider you go with. Rates vary between insurers for the same person buying the same product. The differences can be substantial.

The open market option: shop around

You are under no obligation to buy your annuity from your existing pension provider. This is the open market option, and it matters in practice.

FCA data for 2024/25 shows that only around 38% of annuities were sold to the insurer's existing customers. The remaining 62% came from people who shopped around — either buying direct from a different provider or going through an adviser or broker. That's a significant majority of buyers choosing to move, and for good reason.

The starting point before shopping around: check whether your pension has a guaranteed annuity rate (GAR). These are features baked into some older pension contracts — particularly those from the 1970s to 1990s — that promise a rate regardless of market conditions. GARs can be around 9–11%, occasionally higher. Current market rates, good as they are by recent standards, rarely reach that. If your pension has a GAR, the case for staying with your existing provider may be overwhelming. Check before you do anything else.

If you don't have a GAR, use MoneyHelper's comparison tool, get quotes from multiple providers, or take regulated financial advice. The difference between the best and worst rates for the same person buying the same product can translate to thousands of pounds over a retirement.

Tax: what you keep and what you don't

Annuity income is taxed as pension income. Your provider deducts tax via PAYE before paying you, using your tax code. At the end of the year you'll get a P60 showing tax paid. The income counts as part of your total taxable income alongside any other sources — State Pension, earnings, rental income, and so on.

On tax-free cash: you can normally take up to 25% of your pension pot as a tax-free lump sum before using the remainder to buy an annuity. The maximum is capped by the Lump Sum Allowance at £268,275 for most people (higher if you hold certain protections from the old Lifetime Allowance regime). The more you take as tax-free cash, the smaller the pot left for the annuity. There's more detail on how this works in the 25% tax-free lump sum guide.

One important nuance if you're coming from drawdown: if you annuitise money that's already been moved into a drawdown fund, it does not generate a fresh entitlement to a pension commencement lump sum. You've already crystallised that money. You can't take another 25% tax-free on top.

For the full picture on how pension income is taxed — including how it interacts with the personal allowance and higher rate thresholds — see UK pension tax rules explained.

Annuity versus drawdown: the actual trade-off

This is the question most people are really asking. The honest answer is that neither is universally better.

Annuity: guaranteed income for life, no investment decisions to make, protection against outliving your savings. You cannot access the capital, cannot change the income, and (unless you add protections) cannot pass the remaining pot to heirs. Suits people who want predictability and simplicity, or who have no other guaranteed income beyond the State Pension.

Drawdown: money stays invested, income is flexible, pot can be passed on to beneficiaries (particularly tax-efficiently before age 75). But your income can fall if markets fall, your pot can run out, and you need to keep making investment decisions indefinitely. Suits people who want flexibility and can tolerate uncertainty. See the full pension withdrawal guide for how it works in practice.

The most common answer in practice is neither one nor the other exclusively. Many people use an annuity to cover fixed essential costs — bills, food, housing — and keep the rest in drawdown for flexibility. That way, a market downturn doesn't mean choosing between heating and eating.

Death benefits: what happens to your annuity

A plain single-life annuity stops when you die. Nothing passes to your estate. If you die the day after buying it, that's that.

To change this, you add optional protections at the point of purchase:

Joint-life continuation — a percentage of your income (typically 50%, 66%, or 100%) continues to your spouse or partner for their lifetime. Reduces your starting income.

Guarantee period — income continues to your beneficiaries for a fixed number of years (up to 30) even if you die within that period. If you die after the guarantee period, nothing is paid. Alternatively, beneficiaries may receive a lump sum equivalent to the remaining payments.

Value protection — if the total paid out is less than the original purchase price when you die, a lump sum equal to the shortfall is paid to your beneficiaries. Death benefits from annuities are generally taxed as the beneficiary's income rather than being paid free of tax.

One thing worth flagging: from 6 April 2027, the government has announced that most unused pension funds and death benefits will be brought within the scope of Inheritance Tax. Continuing annuity payments are specifically excluded from that change — but it is worth being aware that the broader pension and inheritance tax landscape is shifting. The pension inheritance tax guide has the current rules and what's changing.

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Key takeaway: A pension annuity trades flexibility for certainty. Before you buy, always check for guaranteed annuity rates in your existing pension, shop around for quotes, and disclose your health fully — all three can have a significant impact on the income you receive.

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Frequently asked questions

What is a pension annuity?

A pension annuity is a contract where you use some or all of your pension pot to buy a guaranteed income from an insurer. A lifetime annuity pays that income for the rest of your life, no matter how long you live. In exchange for that certainty, you give up flexibility — once purchased, an annuity generally cannot be reversed.

How much annuity will £100,000 buy?

Rates change daily and depend on your age, health, and the options you choose. As a rough guide, in late 2025 a healthy 65-year-old could get around £7,000 to £7,500 a year from a single-life level annuity with a £100,000 pot. Poorer health, a joint-life option, or inflation-linking would all change this figure significantly.

Is an annuity better than drawdown?

It depends entirely on your priorities. An annuity gives you certainty — a fixed income for life that you cannot outlive. Drawdown keeps your money invested and gives you flexibility, but your income can fall and your pot can run out. Many people use a combination: an annuity to cover essential bills, drawdown for the rest.

Can I take a tax-free lump sum and still buy an annuity?

Yes. You can take up to 25% of your pension as a tax-free lump sum — subject to the Lump Sum Allowance of £268,275 — and use the remainder to buy an annuity. The more you take as tax-free cash, the smaller the pot available for the annuity and the lower the resulting income.

What happens to my annuity when I die?

It depends on the options you chose when you bought it. A basic single-life annuity stops on your death with nothing paid to your estate. If you added a joint-life option, your spouse or partner continues to receive a portion of the income. A guarantee period means payments continue to your beneficiaries for a set number of years even if you die early.