What is an annuity?
In brief: An annuity converts a lump sum (usually from a pension pot) into a guaranteed income for life. Once purchased, it cannot be reversed. The income amount depends on your age, the pot size, interest rates at the time, and the options you choose.
An annuity is an insurance product. You hand over a sum of money — typically from a crystallised pension — and in return receive a regular income for the rest of your life. The insurance company takes on the risk that you live longer than expected.
Types of annuity
Level annuity: Pays the same amount every year. Higher initial income but loses purchasing power to inflation over time.
Escalating annuity: Income increases each year by a fixed percentage (e.g., 3%) or in line with inflation (RPI/CPI). Lower starting income but maintains purchasing power.
Joint-life annuity: Continues paying (often at a reduced rate, e.g., 50-66%) to a surviving partner after the annuity holder dies.
Single-life annuity: Payments stop when the annuity holder dies. Higher income than joint-life but provides no survivor benefit.
Annuity rates
The income you receive depends on annuity rates at the time of purchase. These are influenced by:
- Your age (older = higher rate, because the expected payout period is shorter)
- Long-term interest rates (higher rates = higher annuity income)
- Health conditions (enhanced annuities may pay more if you have reduced life expectancy)
- The options you choose (escalation, joint-life, guarantee period)
Annuity rates vary between providers. The income offered by one provider may differ significantly from another for the same age and pot size. Comparing rates before purchasing is known as the "open market option."
Annuities in retirement projections
Annuity income is modelled as a fixed income event starting in the year of purchase, with the amount based on current annuity rate quotes. This approach captures the income stream without requiring a specific annuity-purchase event type.
Full annuity modelling — including direct conversion of drawdown funds to annuity income — may be supported in retirement modelling tools in future.
These projections are for modelling purposes only. They do not constitute financial advice. Tax rules are subject to change. Please consult a qualified financial adviser before making financial decisions.