The decision nobody talks about clearly
If you are reading this, there is a reasonable chance you are facing a decision with real weight to it. You have spent years building a pension pot, and at some point you will have to decide what to do with it. One of the options on the table is an annuity — and the thing about annuities is that once you buy one, there is no changing your mind.
That irreversibility is what makes this decision feel significant. It is not a portfolio rebalancing. It is not a withdrawal you can adjust next year. It is a permanent exchange: you hand over a chunk of capital, and you receive a guaranteed income in return — usually for the rest of your life.
Understanding what you are exchanging, and what you are getting, is what this article is about.
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, prevailing interest rates, your health, and the options you choose.
What actually happens when you buy an annuity
You approach an annuity provider — typically a life insurance company — and hand over a sum of money. In return, they pay you a fixed income for as long as you live. The insurance company takes on what actuaries call “longevity risk”: the possibility that you live much longer than average.
From your perspective, the appeal is certainty. You know exactly how much is coming in each month, regardless of what markets do, regardless of how long you live. That income does not run out at an inconvenient moment.
The trade-off is that you no longer own the capital. The pot is gone. If you die early, the insurer keeps the difference (unless you have added specific protections, covered below). If investment markets do well, you do not benefit. The exchange is simple: capital for certainty.
Annuities are purchased from a crystallised pension — meaning you have already accessed your pension (either directly via the annuity purchase itself, or from an existing drawdown arrangement). The purchase uses up some or all of your remaining pot.
What determines your annuity rate
The income you receive for every £100,000 you hand over is called the annuity rate. It is not fixed — it varies based on several factors.
Your age. Older buyers receive a higher rate, because the expected payment period is shorter. A 75-year-old buying an annuity will receive significantly more annual income per £100,000 than a 60-year-old.
Prevailing interest rates. Annuity rates move broadly in line with long-term gilt yields. When interest rates are high, annuity rates tend to be higher — the insurer can invest your capital at a better return and pass some of that on. Rates in 2023–2024 were materially higher than the low-rate environment of 2010–2021. This matters because the rate you lock in is the rate you get for life.
Your health and lifestyle. This is one of the least-understood factors. Insurers ask about your health because someone with reduced life expectancy statistically receives fewer payments — so the insurer can afford to pay more per year while still covering their costs. More on this in the enhanced annuities section below.
The options you add. Escalation, joint-life cover, and guarantee periods all reduce your starting income in exchange for additional protections. Choosing any of these lowers the initial rate.
The provider. Annuity rates vary between providers, sometimes substantially. A 65-year-old with a £200,000 pot might be quoted £10,200 a year by one insurer and £11,400 by another. The right to shop around and purchase from any provider on the market — not just your existing pension provider — is known as the open market option. Using it can meaningfully affect the income you receive for the rest of your life.
Types of annuity
There is not a single type of annuity — there are several variants, and most people mix and match features to suit their situation.
Level vs escalating
A level annuity pays the same amount every year. The income is predictable and the starting amount is higher than an escalating annuity. The drawback is that inflation erodes its purchasing power over time. £1,000 a month in 2025 buys noticeably less than £1,000 a month in 2045.
An escalating annuity increases each year, either by a fixed percentage (commonly 2–3%) or in line with an inflation index (RPI or CPI). The starting income is lower than a level annuity, but the income rises over time, maintaining purchasing power. The longer you live, the more the escalation tends to matter.
Single-life vs joint-life
A single-life annuity pays only the annuity holder. When they die, payments stop. This produces the highest income for the individual, but provides nothing to a surviving partner.
A joint-life annuity continues paying a surviving partner after the annuity holder dies — typically at a reduced rate, often 50% or two-thirds of the original income. The starting income is lower than a single-life annuity, but the couple is protected if one partner dies first.
Guarantee periods
A common concern with annuities is the possibility of dying shortly after purchase — having handed over a large capital sum and received very little back. A guarantee period (typically 5 or 10 years) addresses this: if the annuity holder dies within the guarantee period, payments continue to a nominated beneficiary for the remainder of that period. Once the guarantee period ends, payments stop at death.
Adding a guarantee period reduces the starting income slightly but removes the acute downside of an early death immediately after purchase.
Value protection
An alternative to a guarantee period is value protection (also called capital protection). If the annuity holder dies before the total payments have reached the original purchase price, a lump sum representing the shortfall is paid to the estate (less a 35% tax charge under current rules). This is more comprehensive than a guarantee period but also reduces the starting income more significantly.
Enhanced and impaired-life annuities
This is worth understanding even if you consider yourself in reasonable health, because the qualifying conditions are broader than many people expect.
An enhanced annuity pays a higher income to people whose health or lifestyle is likely to reduce their life expectancy. The insurer’s logic is straightforward: if someone is expected to receive fewer payments, the insurer can afford to pay more per year and still break even.
Qualifying conditions include — but are not limited to — type 2 diabetes, heart disease, high blood pressure, high cholesterol, a history of cancer, stroke, kidney disease, COPD, and others. Lifestyle factors including smoking also qualify in most cases.
The difference in income can be substantial. Someone with qualifying health conditions might receive 20–30% more annual income per £100,000 than someone with a standard rate, depending on the severity of their conditions. For some serious conditions, the uplift is higher still.
The key point: do not assume you will receive a standard rate without checking. Any annuity provider operating in the UK is required to ask about health and lifestyle at the point of application. If your circumstances qualify for an enhanced rate, that higher income is available to you — but only if you disclose the relevant information and shop the market.
How annuity income is taxed
Annuity income is treated as earned income and taxed accordingly. It is added to your other income — State Pension, any employment or self-employment income, drawdown withdrawals, rental income — and your combined income is assessed against the standard income tax bands.
For 2026/27, those bands are (frozen until April 2031):
- Personal Allowance: £12,570 (no tax)
- Basic rate: 20% on income from £12,571 to £50,270
- Higher rate: 40% on income from £50,271 to £125,140
- Additional rate: 45% on income above £125,140
There is no special treatment for annuity income — it sits in the same pile as everything else. This means that if your State Pension, a defined benefit pension, and an annuity together exceed the Personal Allowance, you will pay income tax on the excess. If the total crosses £50,270, some of your income will be taxed at 40%.
One practical consequence: annuity income is fixed. You cannot reduce it in a high-income year or increase it in a low-income year the way you can with drawdown. This means there is less flexibility to manage your tax position once the annuity is in place.
Annuities alongside drawdown (partial annuitisation)
Annuities and drawdown are not mutually exclusive. Many people use part of their pension pot to buy an annuity — covering essential spending — while keeping the rest in drawdown for flexibility and the possibility of investment growth.
The logic behind this split is straightforward. An annuity covering your fixed costs (housing, bills, food) means you are never in a position where you have to sell investments at an unfavourable moment just to pay for necessities. The drawdown portion can then be managed with a longer time horizon, taken when markets are favourable, or left to grow.
This approach — sometimes called partial annuitisation — keeps some capital accessible while removing longevity risk from the portion that matters most. It also preserves some flexibility to pass remaining drawdown funds to beneficiaries, which an annuity does not offer (beyond any guarantee period or value protection you have added).
There is no single correct split. The proportion someone puts into an annuity depends on their total income from other sources, their fixed expenses, their attitude to leaving an inheritance, and their health. These are personal variables — retirement modelling tools can show the income profile of different splits, but they cannot determine which split is right for any given person.
The irreversibility point
It is worth returning to this because it shapes everything about how annuities are evaluated.
Once you purchase an annuity, you cannot undo it. The capital is gone. You cannot access it in an emergency. You cannot change your mind if interest rates rise significantly after you buy. You cannot adjust the income amount if your expenses change. If you die much earlier than expected, the remaining value (beyond any guarantee or value protection you selected) stays with the insurer.
This is not a reason to avoid annuities — the certainty they provide has genuine value, particularly for covering essential income. But it does mean the decision deserves care and accurate information. The open market option exists for exactly this reason: to ensure that people are not locked into the first rate they are offered, from a provider they happen to have accumulated with.
Annuities in retirement projections
When modelling retirement income, annuity income can be represented as a fixed income stream starting from the year of purchase. This allows you to see how guaranteed income interacts with drawdown withdrawals, State Pension, and any other income sources across your projected retirement — including the tax position in each year.
The income amount used in projections needs to reflect a current market quote for your specific circumstances, including any enhanced rate you may qualify for.
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.