What are annuities?

What are annuities?

Buying an annuity involves swapping your pension savings for a guaranteed regular income that will last for the rest of your life.

How much you get is determined by the rate offered by the annuity provider, so it's important to shop around. 

Annuity rates are based on several factors, ranging from the size of your pension and your age to the external economic environment. 

Buying an annuity used to be the only option for most people with a defined contribution pension, but there are now other ways to access your retirement savings. 

It's up to you whether you decide to convert all your savings into an annuity, or whether you buy an annuity with a smaller amount and take the rest of your money in a different way (for example, pension drawdown).   

If you take out an annuity as a result of using the service from HUB Financial Solutions, Which? will earn a commission to help fund our not-for-profit mission.

Check your annuity options

Which? says you can trust HUB Financial Solutions to compare across the whole market

Find out more

How much annuity income will you get?

When you get a quote for an annuity, you'll be given an annuity rate as a percentage. This will determine how much income you get each year. 

For example, if you have £100,000 in your pension pot and are offered an annuity rate of 5%, you'll get an annual income of around £5,000 a year. 

You'll generally find that the older you are when you arrange an annuity, the higher the annuity rate you'll get, reflecting the fact that the annuity provider won't have to pay out for as long. 

You'll also be offered a higher rate if you have a serious health condition, for the same reason. 

Money from an annuity can be paid monthly, quarterly, half-yearly or yearly, depending on the company.

These rates shown below are for illustration only. You can run your own annuity rate comparison using the Money Helper annuity calculator.

Is an annuity right for you?

Annuities could be right for you if...

• you want a guaranteed income for the rest of your life
• you don't want your retirement income to be subject to stock market fluctuations (as with pension drawdown)
• you want your income to rise with inflation
• you've been in poor health (as you will qualify for a higher income)

An annuity might not be the best option if…

• you have a very short life expectancy
• you're likely to change your mind
• you want to keep your money invested
• your income needs are likely to change significantly in future

What are the different types of annuity?

The type of annuity you choose will determine how much income you get and what happens to payments when you die.  

You'll also need to think about whether you want protection against inflation and whether you qualify for higher rates because of a health condition.

Lifetime annuities

Most annuities are lifetime annuities. They will pay out a guaranteed amount of money for the rest of your life. The amount is agreed when you take out the annuity. You’ll also decide how often you’ll get it and whether you want to go for other product features, such as linking the payments to inflation or arranging for the payments to go to a loved one if you die.

Level annuities

Level annuities pay out a flat amount every year for the rest of your life. The advantage of this type of annuity is that you get the highest rate possible at the start, compared with escalating annuities (see below), which start off at a lower rate.

However, because level annuity payments won't keep up with inflation, you won't be able to buy as much with your money in later years.

Escalating annuities

These pay out an increasing amount each year. You can opt for a specific percentage increase - say, 3% - or link the increases to inflation. The latter is usually pegged to the Retail Prices Index (RPI).

Protecting your retirement income from inflation in this way might seem like a no-brainer, but in reality it's a more complicated decision.

You'll need to bear in mind that payments will be much lower than a level annuity to begin with, and it could take as much as 15 to 20 years for the overall income you've received to exceed what you would have got from a level annuity. 

Enhanced annuities

Standard annuities are based on average life expectancy, currently 84 for men and 86 for women.

But of course not everyone lives this long, so some providers offer enhanced annuities to people in poor health or with lifestyle conditions that mean they might die earlier.

If you qualify, you can increase your annuity income by as much as 20-30%. 

Single-life annuities

Single-life annuities - where the income is paid only to you - account for around two-thirds of all those sold.

They pay higher rates than joint-life annuities, which provide for your partner when you die (see below).

Joint-life annuities

A joint-life annuity will start making payments to your partner or spouse when you die, at a percentage you choose at the outset. For example, this might be half the original amount. 

The initial rate will be lower than for a single-life annuity, but a joint-life annuity could end up paying out more in the long run.

Guaranteed annuities

An annuity with a guarantee period means your retirement income will be paid out for a set number of years from the time you take out the policy, even if you die during this time.

For example, if you take out an annuity with a 10-year guarantee period and die after three years, the payments would continue for seven more years. Adding a guarantee will not reduce the income level significantly.

Value-protected annuities

This type of annuity involves ring-fencing a proportion of the amount you paid for your annuity to pay out as a lump sum to your beneficiaries when you die (minus any payments already made to you).

Choosing this option means you'll get less income from your annuity at the outset. 

Fixed-term annuities

Fixed-term annuities are like standard annuities in that they pay a set amount each year.

The difference is that they stop after a certain period (normally five or ten years). At this point you'll be paid a set amount, which is agreed at the outset. 

You aren't locked into a single rate for life and you can do what you like with the lump sum once the fixed term has ended.

Deferred annuities

With a deferred annuity, you delay the start date of your annuity payments until an agreed date in the future. This can prove useful if you’re still earning and getting extra income via an annuity would push you into a higher tax band.

In the interim period, your provider will probably invest your money. You’ll get an agreed rate of interest on it, with the exact amount depending on your age and how much money you’ve paid in.

Purchased life annuities

A purchased life annuity is retirement income that you buy with money that doesn’t come from a pension pot. For example, the money could come from from a house sale, your savings or an inheritance.

Regular annuity payments include a return of part of the sum invested (the capital) plus the part that is interest. You won’t pay income tax on the capital, but you will pay tax on the interest part of your annuity income.

Immediate needs annuities

Immediate need annuities provides a guaranteed monthly income to help pay for long-term care.

They are available from age 60 and there is no maximum upper age limit. The income can either remain static each or rise in line with inflation. 

The income provided is tax-free and can be paid either to a care agency, if care at home is provided, or to a care home provider.

Make your money go further

Find the best deals, avoid scams, and grow your savings with our expert guidance. From only £4.99 a month.

Join Which? Money

Cancel anytime.

When should you arrange an annuity?

You can access your private pension savings once you turn 55. After that, it's entirely up to you how and when you take this money.

Waiting until later on in retirement to buy an annuity would mean more time for your pension to grow and you'd benefit from a higher annuity rate to reflect that fact your life expectancy will now be lower. 

Bear in mind that you can opt for an annuity alongside using pension drawdown (where you keep your money invested and take money as and when you need it). 

How do you arrange an annuity?

Once you've converted a pension pot into annual payments you can't reverse the process, so it's important to take the time to choose the right annuity for you.

After deciding what level of income you need, you should always shop around to find the best rate, rather than just settling for the one offered by your existing pension provider. 

When you get a quotation, the rate is usually guaranteed for 45 days. If you think rates have gone up since you first got a quote from a provider, request an updated one.

Buying an annuity is a big decision, so seeking help from an independent financial adviser is a good idea. 

Do you pay tax on annuity income?

The money you get paid from an annuity is subject to income tax.

Your annuity income will be added to any other sources of income you have in retirement, including the state pension, to determine the rate of income tax you'll pay.

Find out more in our guide to tax on pensions.

What happens to your annuity when you die?

It depends what type of annuity you buy. For most types, the provider keeps anything that's left when you die.

But with joint-life, guaranteed or value-protected annuities, your spouse, partner or anyone else you've nominated will start receiving payments tax-free if you die before age 75.

Payments will be taxed at their usual rate of income tax if you're over 75 when you die.