Everything you need to know about annuities

Sales of annuities have soared over the past few years as the amount of money they pay to pension savers has increased. Because they are closely linked to interest rates, rising rates have meant that the products have become better value.

They had become unpopular after then-chancellor George Osborne famously declared a decade ago that no one would have to buy an annuity in retirement and the Pension Freedoms, which gave people the right to use their pensions as they wish, were introduced.  

And, with annuity payouts linked to interest rates, years of rock-bottom rates didn’t do much to boost their popularity either. Unsurprisingly, many retirees felt they could get better value for money by keeping their pensions invested instead, and drawing an income whenever they liked. 

However, as interest rates have risen, annuities have made something of a comeback. 82,061 annuities were sold in 2023/24, up 39% on the previous year, according to the Financial Conduct Authority. 

What's on this page: 

• What are annuities?
• What are the different types of annuity?
• What are the pros and cons of annuities?
• How much income can I get with an annuity?
• Is an annuity right for you?

What are annuities?

In a nutshell, an annuity is an insurance product that gives you a guaranteed income for an agreed period, such as for life, or for a set number of years, in exchange for your pension. When you buy an annuity, you effectively give your pension (either the whole pot, or just part of it) to the insurer, who then pays you a regular, guaranteed amount of money.

What are the different types of annuity?

1. Lifetime annuity

The most common type of annuity is a standard or “single life” lifetime annuity. This means it will pay out for the rest of your life. You can choose a flat-rate annuity, or an increasing income annuity. An increasing income annuity will rise each year, either by a set percentage, or linked to inflation. This can help shield you from future increases in the cost of living. Depending on how long you live, you may receive more money overall from an increasing income annuity than a fixed one. But for the first few years at least, the income paid out is less than a fixed annuity.

Payments will normally stop when you die: you won’t have a remaining pension pot to pass onto loved ones. However, you can choose a guaranteed minimum payment period (a maximum of 30 years, or until you reach age 100 if you are over 70 when you take out the annuity). This means that your beneficiary will continue to get the payments if you die within the minimum period. You will get a lower annual income if you choose this option.

Another option is value protection, where you choose to protect a certain percentage of the amount used to buy your annuity. This means when you die a lump sum will be paid to your beneficiary. This will reduce the income you get from the annuity at the outset.

2. Joint annuity

A joint lifetime annuity pays an income to a spouse or other dependant after you die. These are usually designed for couples. You can choose for the full payment to continue or a lower amount, such as 50%. Joint annuities will usually pay a lower income than single-life ones, to reflect the fact that they may pay out for a longer period of time, if the other person outlives you.

3. Enhanced annuity

This is also known as an impaired annuity. They offer a higher income to people who have a long-term medical condition (such as cancer, diabetes, or heart problems), take medication or have an unhealthy lifestyle (for example who are overweight or who smoke).

Helen Morrissey, head of retirement analysis at the investment platform Hargreaves Lansdown, says it all comes down to how long underwriters expect you to live: “If you have a condition that could have an impact on your life expectancy, you typically receive a higher annuity income based on the expectation of a shorter life.” It’s important to tell any potential provider about your health, in case you are eligible to get the better rates that this kind of annuity can offer.

4. Investment-linked annuity

This is a type of lifetime annuity where part of your pension pot is used to pay a fixed (guaranteed) annuity, and part of it is invested. How much additional income you get will then depend on how investment markets perform.

5. Fixed-term annuity

This pays a guaranteed income for a set period of time, between one and 40 years. Typically these are used for relatively short-term income (five to ten years). Some people do this because they think that interest rates will go up in future. Some of your pension pot will be used for the annuity, and the rest of it is left invested.

At the end of the term, you usually get a “maturity amount”, based on how your investment has performed, minus the income you have received so far. You can then choose whether to buy a lifetime annuity. 

The maturity amount can usually be paid to a beneficiary if you die before the fixed term ends. If you are not happy with payments stopping after you have died, it is also possible to buy additional guarantees. For example, you can choose a policy that guarantees payments will continues for a certain period (for example five or 10 years), irrespective of when you die. Alternatively, you can choose value protection which ensures a lump sum will be paid when you die. Choosing options such as these usually means that you will receive a lower annual income.

What are the pros and cons of annuities?

Pros

• Security. If you choose a lifetime annuity, you’ll receive an income from the annuity regardless of how long you live (or for a fixed term if that’s the type of annuity you choose). In contrast, if you try and manage your money via income drawdown, you could run out of money, or spend your money too frugally and have lots left over when you die. 
• Your income is fixed. It doesn’t matter how stock markets perform, as there’s no investment risk to you – instead the risk is transferred to the annuity provider. The one exception is if you choose an investment annuity, which will be affected by stock market performance.
• You can choose the type you want. This includes having one that rises with inflation or one that pays an income to a partner when you die. You can also buy protection or guarantees if you're worried about getting poor value for money. 
• Protection for your money. Annuities provided by UK-regulated insurers are protected by the Financial Services Compensation Scheme, with no upper limit.

Cons

• They are not flexible. You can’t cash in your policy or change the income so that it’s higher or lower in certain years. They are not reversible, so (apart from the cooling-off period) you can’t change your mind about the annuity.
• Hard to be sure how much value you’ll get. With a lifetime annuity, if you die relatively quickly, you’ll receive much less than someone who has a lengthy retirement. Some people choose a joint annuity or a guaranteed minimum payment period, to reduce the risk that they’ll lose out if they die sooner (although these options usually mean you get a reduced annual income).
• Your income (often) dies with you. This means there’s nothing left for your partner or dependants – unless you buy a joint annuity or one with guarantees or value protection (and again, these options usually mean a reduced annual income).
• You could miss out on any investment growth. If stock markets perform well, you won’t reap any benefits. (The exception is an investment annuity.)
• Additional costs can add up. Providers may charge administrative fees, fund transfer fees, premium taxes, and underlying fund expenses. Make sure you shop around for the best annuity and that you’re clear about the charges as well as the income levels before you choose a provider.

How much income can I get with an annuity?

The amount you get from an annuity is influenced by interest rates at the time of your purchase (and, of course, by the size of your pension pot, and the proportion of it you use to buy an annuity). Annuity providers usually buy government bonds to provide income, and the return on these is linked to the Bank of England base rate and inflation. So in general, the lower the Bank of England interest rate at the time of your purchase, the lower the income you’ll get. (Investment annuities work a bit differently, as outlined above.) There are also differences between providers, so it’s important to shop around.

Annuity providers will also take into account other factors such as your age, state of health, and what type of annuity you choose. For example, a healthy 65-year-old with a £100,000 pension could currently receive up to £7,560 a year from a single-life standard annuity, according to Hargreaves Lansdown.

If you want to build some protection in and have a five-year guarantee (which means your beneficiaries will receive some money if you die within five years), the annual income falls to £7,504. For a joint annuity, the same person could receive £6,932 a year.

If you’d like your annuity to rise each year in line with the retail prices index to protect against inflation, and have a five-year guarantee, the starting income would be much lower, at £4,806.

Rates will be higher if you aren’t in good health or if you smoke. A 65-year-old who smokes 10 cigarettes a day, for example, could get an income of £7,975 in exchange for a £100,000 pot (a single-life annuity with no guarantees). Someone with diabetes, meanwhile, could get up to £7,863, while someone who’s had a stroke could receive up to £9,426.

Is an annuity right for you?

Although annuities are often viewed as inflexible, they may be worth considering as part of your overall retirement strategy. You don’t need to ‘annuitise’ your whole pot, for example, nor do you need to buy an annuity as soon as you retire, or at age 65. You could choose to buy an annuity with part of your pot and use income drawdown as well, or combine with other sources of income such as your ISA savings.

Megan Rimmer, chartered financial planner at the wealth manager Quilter Cheviot, comments: “Some savers may choose to fully annuitise their full pension, whereas others may opt to annuitise only some of it to cover their basic outgoings, with the rest left to be invested for potential growth and an option to take flexible amounts that change with their future outgoings.”

Morrissey says mixing income drawdown with an annuity will “deliver both certainty and flexibility”. She adds that you can also buy annuities with chunks of your pension as you get older. The older you are, the higher rate you get (a 75-year-old could get £9,520 from a single-life annuity versus £7,560 for a 65-year-old).

“You can annuitise in slices as your needs change in retirement, and you should get high rates as you age. If you develop a condition such as diabetes, or you get ill, you can also qualify for an enhanced annuity, which will give you a higher income.”