What you are actually buying
An annuity is a swap. You hand an insurer a lump sum, permanently, and in return it pays you an agreed income every month for as long as you live, however long that turns out to be. The insurer can make that promise because it is doing it for tens of thousands of people at once: some die early and some live to a hundred, and only the average has to be right. That pooling is the thing you cannot reproduce on your own with the same pot of money, and it is what you are paying for.
What you give up is everything else. The money stops being yours: it cannot be reclaimed, sold, moved to another provider or left to anyone unless you paid for one of the options that provides for it. The rate is fixed on the day you buy, so it locks in whatever gilt yields happen to be that week for the rest of your life. And it is irreversible after a short cancellation period. Those are the terms in exchange for never having to think about running out of money, and whether that is a good trade depends entirely on what else you have and how much certainty is worth to you.
What each choice costs, at age 65
The estimator above has a lot of options and it is not obvious which ones matter. Every line below prices £100,000 at age 65 on the gilt yields shown at the top of this page, changing exactly one thing from the first row. The percentage is the income as a share of that plain single-life annuity.
| Option | Yearly income | Share of the plain version |
|---|---|---|
| Single life, level, 5-year guarantee The comparison used below | £7,869 | 100% |
| Half continues to a surviving partner Partner three years younger | £7,377 | 94% |
| All of it continues to a surviving partner Partner three years younger | £6,943 | 88% |
| Guarantee period of 10 years instead of 5 Payments continue to your estate if you die early | £7,735 | 98% |
| Rising by 3% every year Starts lower, overtakes later | £5,863 | 75% |
| Rising with inflation Linked to the retail prices index | £5,422 | 69% |
| Purchase price protected on death Anything not yet paid out is returned | £7,493 | 95% |
| Smoker, or a treated condition Middle of the enhanced band used by the estimator | £8,493 | 108% |
| Bought at 70 rather than 65 Five fewer years of expected payments | £8,715 | 111% |
Estimates from this site’s own pricing model, not offers, and not rates from any particular insurer. Real figures differ between providers and with your postcode and medical history.
Three things in that table surprise people. Protecting a partner is expensive, because the insurer may now be paying for two lifetimes rather than one. A guarantee period is cheap, because it only matters in the minority of cases where someone dies early. And declaring a health condition raises the income rather than lowering it, which is the opposite of how insurance normally works, because here the insurer is betting on how long it will be paying rather than on whether it will have to pay at all.
Level or rising: where the crossover falls
A level annuity pays the same cash amount forever, so its buying power falls every year. An escalating one starts lower and climbs. On today’s yields, an annuity rising at 3% a year starts roughly 25% below the level version, and the total amount actually paid out does not overtake the level annuity until about year 20, which for someone buying at 65 is around age 85.
Put plainly: choosing the rising version is a bet on living beyond your late eighties, or a decision to pay for protection against a long retirement eroded by inflation, or both. Choosing the level version is a bet the other way, and it also front-loads the income into the years when most people spend more of it. The estimator’s “same pot, other choices” table above works the comparison for your own age and pot rather than the example here.
How this compares with leaving the pot invested
The main alternative is drawdown: leaving the money invested and taking what you need from it. The two are not really competitors so much as opposite ends of a spectrum, and the differences are worth setting out plainly rather than as a recommendation either way.
| Annuity | Leaving it invested | |
|---|---|---|
| Income | Fixed and guaranteed for life | Varies with markets and with what you withdraw |
| Risk of running out | None | Real, and largest if markets fall early in retirement |
| Leaving money behind | Only if you pay for a guarantee, joint life or value protection | Whatever is left in the pot |
| Flexibility | None once the cancellation period ends | Change the amount, stop, or buy an annuity later |
| Effort | None after purchase | Ongoing decisions about investments and withdrawal rates |
| Effect of rising yields | Locked in at purchase, good or bad | Still open to whatever comes later |
Because a pot can be split, the choice is not all-or-nothing. Covering fixed, unavoidable bills with guaranteed income and keeping the rest invested and accessible is a common shape, as is buying in stages over several years so that no single week’s gilt yields decide the whole outcome.
Tax, and why the headline figure is not what arrives
Annuity income from a pension is taxable as earnings, exactly like a salary, and it is paid through PAYE with tax deducted before it reaches you. It does not attract National Insurance. It stacks on top of your State Pension, which is itself taxable but is paid gross, so the tax on both is usually collected from the annuity. That is why a full State Pension and a modest annuity together can put someone into tax even though neither alone would. The estimator works this out for you in the “what you would keep after tax” panel above, for England, Wales and Northern Ireland or for Scotland.
What people do before buying
- Book a free Pension Wise appointment. Anyone aged 50 or over with a defined contribution pension can have a free, impartial guidance session from the government-backed service. It is guidance rather than advice, and it is free.
- Use the open market option. Your existing provider’s offer is one price among many, and the spread between the best and worst rates available on the same day is commonly worth more than 10% of the income for the rest of your life.
- Fill in the health and lifestyle questionnaire fully. Enhanced terms are never applied automatically. Conditions that feel too minor to mention, and smoking that stopped years ago, both routinely change the figure.
- Check for a guaranteed annuity rate. Some older pensions, particularly those taken out before the late 1980s, carry a contractual rate far above anything on sale today. Giving one up by moving the pot elsewhere is an expensive mistake and providers do not always make it obvious.
- Settle the options before signing. Joint life, guarantee period, escalation and value protection cannot be added or removed afterwards.
Mistakes that come up again and again
- Taking the first offer. The provider you saved with has no obligation to be competitive, and frequently is not.
- Buying single life while married. It produces the biggest number on the page and can leave a surviving partner with nothing but the State Pension.
- Not mentioning health. The commonest reason people receive less than they could have.
- Comparing a level annuity with a rising one on the starting figure alone. They are different products with different totals over a lifetime.
- Using the whole pot at once. There is rarely any requirement to, and staging the purchase spreads the risk of buying at a bad moment.
- Forgetting the tax. The quoted income is before tax; the State Pension usually sits underneath it and uses up the personal allowance first.
Questions people ask
What happens to the money if I die soon after buying?
With a plain single-life annuity and no guarantee period, the income simply stops and nothing is returned, which is the risk the insurer is being paid to take on the other side. Three optional features change that. A guarantee period keeps the payments running for a set number of years whatever happens. A joint-life annuity continues a share of the income to a surviving partner for the rest of their life. Value protection returns the purchase price less whatever income has already been paid. Each of them costs income, and the table above shows roughly how much at age 65.
Can I change my mind afterwards?
There is normally a cancellation period of 30 days from the point of setting the annuity up, during which it can be unwound. After that it is permanent: an annuity cannot be sold, surrendered or switched to another provider, and the terms cannot be varied. That permanence is the single biggest practical difference between an annuity and leaving a pot invested, and it is the reason the options are worth settling before signing rather than after.
What difference does taking the tax-free lump sum first make?
Taking 25% of the pot as a tax-free lump sum leaves 75% to buy the annuity, so the income falls by a quarter. What changes is the tax treatment rather than the total value: the lump sum arrives free of income tax, while every pound of annuity income is taxable as earnings. For most people the lump sum is worth taking for that reason alone, but it is not automatic and the amount is capped, currently at £268,275 across all pensions. Tick the box in the form above to see both versions of the figure.
How long does a rising annuity take to catch up with a level one?
On the yields the estimator is currently using, an annuity rising at 3% a year starts about 25% below a level one at age 65, and the total amount paid out only overtakes the level annuity after about 20 years, so somewhere around age 85. The arithmetic favours a level annuity for anyone who does not expect to live well past that point, and favours a rising one for anyone who does, or who is worried about what inflation does to a fixed income over a long retirement. Neither is the right answer in general.
Do I have to buy from the provider I saved with?
No. The open market option means you can take your pot to any provider that sells annuities, and the difference between the best and worst rates available at any moment is routinely worth more than 10% of the income for life. Providers are required to tell you that shopping around is possible and to show you comparison figures, but they are not required to match a better rate elsewhere. The free government-backed MoneyHelper service publishes a comparison tool, and regulated annuity brokers can run the whole market for you.
Can I buy an annuity with only part of my pension?
Yes, and it is common. Nothing requires the whole pot to be used at once. Some people secure enough guaranteed income to cover their fixed bills, and leave the rest invested and accessible. Others buy in stages over several years, which spreads the risk of buying at a moment when yields happen to be low. Both approaches keep the annuity part permanent while leaving the rest flexible.
Does annuity income affect means-tested benefits or care fees?
It can, in both directions. An annuity converts capital into income, so it reduces the capital counted for means tests such as Pension Credit and local authority care funding, while increasing the income counted. Which way that lands depends entirely on the amounts involved and on which test is being applied. Anyone close to a means-test threshold would want to check the specific rules before converting a large pot, because the effect is not always the intuitive one.
Why do the health questions matter so much?
Insurers price on how long they expect to be paying you, so anything that shortens that expectation raises the income. Smoking, high blood pressure, high cholesterol, diabetes, a heart condition, a cancer history and being significantly overweight can all qualify, as can some occupations and postcodes. The uplift ranges from a few per cent to well over 40% in serious cases. Enhanced terms are not applied automatically: they follow from answering a medical and lifestyle questionnaire honestly and in full, and a great many people never fill one in.
Everything on this page is general information, not financial advice, and the figures are estimates rather than offers. How the model works, how accurate it is and where its data comes from are set out on how annuity rates are worked out. Actual rates for your own circumstances come from insurers, and can be compared free through the government-backed MoneyHelper service or through a regulated adviser or broker.