Annuities explained

An annuity is an insurance product that swaps your pension savings for a guaranteed regular income that will last for the rest of your life¹. You hand over some or all of your pension pot to a life insurance company, and in return it pays you a fixed income, usually every month, until you die². It is one of several ways to turn a defined contribution pension into retirement income, and it is the only one that pays an income that is guaranteed rather than dependent on how investments perform.

The trade-off is permanent and worth understanding before you buy. In exchange for the certainty of a guaranteed income, you give up access to the money itself: once the annuity is bought, the pot is no longer yours, no longer invested, and normally cannot be cashed in or switched¹. What you get depends on your age and gender, the size of your pension pot, interest rates at the time you buy, and sometimes your health³. As a rough guide, a 65-year-old with £100,000 in pension savings could get around £7,800 a year from a single-life level annuity as of May 2025⁴.

An annuity swaps your pension pot for a guaranteed income

The mechanics are simple. When you reach the age at which you can access your pension pot, usually 55⁷, you can use the fund you have built up to buy an annuity from a life insurance company². The insurer takes the money and, in return, pays you a regular income for the rest of your life². How long the insurer ends up paying is the risk it carries, not you: if you live a long time, the payments keep coming; the money cannot run out because markets fell.

That certainty is the annuity's defining feature, and it is what separates it from the main alternative, income drawdown, where your pot stays invested and you take money from it, with the risk that poor returns or long life leave you short¹. An annuity involves no investment risk and no ongoing charges¹. The price of that security is flexibility: after you swap your savings for an annuity, this money is no longer invested and so will no longer have the opportunity to grow¹.

An annuity is one of several options for taking money from your pension, and you do not have to use your whole pot. You can buy an annuity with part of your savings and use the rest differently, or buy a series of annuities at different times and ages⁹. Because the rate you get depends partly on your age, some people buy in stages, though each purchase is final on its own terms.

Types of annuity: lifetime, fixed term and enhanced

Annuities come in three broad shapes, and the differences between them matter more than the differences between providers.

A lifetime annuity pays an income for the rest of your life, unlike a short-term or fixed-term annuity⁹. It is the classic form of the product and what most people mean by "an annuity".

A fixed term annuity, sometimes called a short-term annuity, uses part of your pension pot to buy an annuity that provides a short-term income⁹. Official guidance describes it as giving regular payments for up to five years¹⁰. At the end of the term you get a lump sum back, often called a maturity sum, which you can then use to buy another annuity or take in another way. It trades some security for flexibility, and the comparison page on fixed term or lifetime annuities sets out how they behave side by side.

An enhanced annuity pays a higher income if your health or lifestyle may shorten your lifespan, and is covered in its own section below. There are also annuities bought with money from outside a pension, called purchased life annuities, which are taxed differently.

How much income an annuity pays

Annuity rates are quoted as income per £100,000 of pot. The figures below, from independent analysis of the market, show the range a healthy person could have got in early 2025.

Three things drive these numbers. First, age: the older you are when you arrange an annuity, the higher the rate you will get, because the insurer expects to pay out for fewer years¹. Second, the options you choose: a joint-life annuity, rising income or guarantees all reduce the starting payment. Third, the provider: the gap between the highest and lowest rate for a healthy 65-year-old was 10% in January 2025, which is why shopping around matters so much¹¹.

What the income needs to cover is a bigger question. Independent calculations of what a "moderate" retirement standard costs suggest a single person buying an annuity alongside the State Pension would need a pot of between £335,000 and £505,000, and a couple between £340,000 and £510,000; for a "comfortable" standard, a two-person household buying an annuity would need £630,000 to £910,000¹². Those figures are based on annuity rates of between £5,000 and £7,500 per £100,000 of pension savings¹². The page on how much you need to retire goes deeper.

Enhanced annuities: up to 30% more if your health qualifies

Enhanced annuities, also called impaired life annuities, pay out a higher income if your health or lifestyle may shorten your lifespan⁹. They exist because an insurer pricing an annuity is estimating how long it will be paying. If you have an existing health condition, smoke, or are overweight, that estimate changes, and the insurer will pay more per pound of pot⁹.

The uplift can be substantial. Sharing health information with your provider could get you as much as 30% more than a standard annuity⁴. In one market comparison, an overweight 65-year-old smoker on medication for high blood pressure and high cholesterol was offered rates between 6% and 15% more than a standard annuity on a £100,000 pension¹³. The range is wide because each insurer prices conditions differently, which is another reason to compare quotes from several of them.

The health questions are detailed and cover medical history, medication, smoking, drinking, weight and sometimes hospital admissions. Many people qualify who do not expect to: estimates commonly suggest a significant share of retirees could get enhanced terms. The dedicated comparison of enhanced and standard annuities explains the differences, and anyone with any health condition should answer the questions fully rather than assume they will not qualify.

Level or increasing income: how each one behaves

When you buy, you choose how the income behaves over time, and this choice changes the starting amount significantly.

A level annuity pays the same income each year, and has a higher starting income than an escalating annuity⁹. An escalating annuity rises each year at a fixed rate, for example by 3%⁹. An inflation-linked annuity rises each year in line with the retail price index⁹.

The trade is between income now and income later. A 65-year-old with £100,000 in pension savings could get around £7,800 a year from a single-life level annuity, but this falls to around £5,700 a year if they want an annuity that rises by 3% each year⁴. The rising annuity only catches up after many years of increases, and the level annuity can leave you vulnerable to inflation, which might make your annuity income worth less over time⁹.

It helps to compare this with how other retirement income moves. The State Pension rises every year under the triple lock: the basic State Pension increases by whichever is the highest of earnings growth in Great Britain, CPI price growth in the UK, or 2.5 per cent¹⁴, and the new State Pension follows the same rule¹⁵. Someone whose only rising income is the State Pension should think carefully about how a level annuity will feel in twenty years. The page on how pension income is taxed and the wider pensions guide cover how the pieces fit together.

What happens to an annuity when you die

With many types of annuity, payments stop when you die¹⁶. A single-life annuity covers only the policyholder and stops paying out when you die¹⁷, so the income your household relied on disappears at the same moment as the funeral costs appear. This is the biggest single risk of buying the cheapest annuity without thinking about a partner.

The main protections are:

• Joint-life annuity: payments continue to your named beneficiary, usually at two thirds or half of the original payments¹⁶. The survivor's income is guaranteed for the rest of their life.
• Guarantee period: the annuity pays for a minimum number of years even if you die earlier, with the payments going to your estate or a beneficiary.
• Value protection: ringfencing or preserving a proportion of the amount you paid for your annuity, usually 50% or 100%, to return as a lump sum if you die early¹³.

Value protection is less well known than the others and costs less than you might expect. In one example, a healthy 65-year-old with a £100,000 pot and 100% value protection who died five years after purchase would leave £64,140 to be returned to beneficiaries¹³. The cost is a lower income: at age 60 the reduction was £268 a year, at 65 it was £387, and at 70 it was £711¹³.

On inheritance tax, joint-life annuities that continue to pay your partner after you die are still exempt from inheritance tax¹⁷. The government has confirmed the survivor's rights paid from a joint life annuity are not part of the member's estate and are not in scope of inheritance tax, and if the chosen survivor was a spouse or civil partner the usual exemption would apply anyway¹⁸. Single-life annuities are unlikely to be affected by inheritance tax changes because payments usually stop when you die¹⁹. The pages on pension death benefits and pensions and inheritance tax cover the wider picture.

Tax on annuity income and the 25% tax-free lump sum

Annuity income is not tax-free. It counts as retirement income and is taxed as income, so it is added to your other income and taxed at your marginal rate²⁰. If your annuity plus State Pension plus any other income stays within your personal allowance, you pay no tax; above that, the payments are taxed through PAYE like a salary would be.

Before buying an annuity, you can take up to 25% of your pension pot as a tax-free lump sum⁵. The remaining 75% is what typically buys the annuity, and only that part's income is taxed. Common misconceptions about the lump sum, including that it is always tax-free however you use it, are unpicked on the page about tax-free cash from your pension.

Two points of caution. First, taking the tax-free lump sum and then continuing to pay into a pension can trigger the money purchase annual allowance, which sharply limits how much you can contribute and still get tax relief. Second, a large lump sum spent or given away can affect means-tested benefits and later care costs; free guidance on this is available from Pension Wise. All retirement income, whether from drawdown, annuity payments, defined benefit plans or fully cashed-in pensions, is subject to income tax²⁰.

How to buy an annuity and shop around

You do not have to buy your annuity from your pension provider: you can shop around and compare offers from different providers¹⁰. This right is called the open market option, and using it matters because of the 10% gap between the highest and lowest rates recorded for identical buyers¹¹.

The process in order:

1. Check your own provider's offer first. Your pension provider may still offer a higher payment than elsewhere, so its quote is the starting point for comparison⁹. Some older policies include a guaranteed annuity rate, which can convert your pension into a higher guaranteed income than you can get elsewhere²³. These are valuable and often missed; the page on guaranteed annuity rates explains them.
2. Answer the health questions. Declare every condition, medication and lifestyle factor: this is what unlocks enhanced terms⁹.
3. Compare quotes from several providers. Annuity quotes are normally valid for a period, so gather them together before deciding¹¹. The page on annuity providers and shopping around lists who operates in the market.
4. Choose your features: single or joint life, level or rising income, guarantee period, value protection⁹.
5. Choose how often it is paid: an annuity pays a regular guaranteed income, and you can usually choose monthly, quarterly, six-monthly or yearly³.

Free, impartial guidance is available from Pension Wise, and the State Pension, which is usually paid every four weeks²⁴, forms the base of most people's retirement income alongside whatever they buy.

Once bought, an annuity usually cannot be changed

This is the point that catches people out. Once you buy an annuity, the decision cannot be unwound: you will not be able to alter your level of income or switch to another provider²⁷. You cannot usually change your mind once you have bought one²⁸, and you cannot reverse the process after purchase¹¹. The money is no longer invested and will no longer have the opportunity to grow¹.

There is no secondary market to sell into. A government plan to let people sell their annuity income for a lump sum was scrapped before it launched, as the page on the secondary annuity market explains. So the purchase is permanent in a way few other financial decisions are.

This permanence is exactly why the pre-purchase steps matter: shopping around, answering health questions honestly, and thinking through the joint-life and inflation choices. It is also why free guidance from Pension Wise, and paid financial advice for larger or more complicated pots, are worth considering before committing. The comparison between drawdown and annuities sets out the alternative for people who want to keep access.

FSCS protection and where to get help

Annuities provided by UK-regulated insurers are protected by the Financial Services Compensation Scheme (FSCS) up to 100% of their value, with no upper limit⁸. This is more generous than the cover on bank deposits, which is capped at £120,000 per person per authorised firm²⁹, and it means that if the insurer paying your annuity fails, FSCS steps in so the income continues.

The protection has conditions. FSCS can only protect you if the Prudential Regulation Authority has authorised your insurance provider²⁹, so buying from a UK-regulated insurer matters. FSCS also protects pension advice, so if an adviser who recommended an annuity fails, compensation may be available³⁰. FSCS itself suggests asking any provider a set of questions before you commit: does FSCS protect my pension, how much of my pot is protected, am I still protected if I buy an annuity, and what if I buy other products with my pension pot³¹.

Where to get help:

• Pension Wise: free, impartial guidance for people aged 50 and over with a defined contribution pension, on all your options, not just annuities.
• The Financial Ombudsman Service: handles complaints about annuity providers and advisers; the page on complaining about a provider explains the process.
• FSCS: check a firm and what protection applies at fscs.org.uk³¹.
• Independent Age and Age UK: free charity guidance on pensions and retirement income for older people⁹.