March 18, 2026

What Is an Annuity – and Who Should Consider Buying One?

Nick Pensions & Benefits, Investing reviews, pensions, retirement 2 Comments

If you’re approaching retirement (or have retired already), you’ve probably come across the term annuity. For some people it represents security and peace of mind. For others it feels restrictive and poor value.

So what exactly is an annuity – and who should consider buying one?

Let’s take a closer look.

What Is an Annuity?

In simple terms, an annuity is a financial product that converts a lump sum of money – typically from your pension pot – into a guaranteed regular income for life or for a fixed period.

You buy an annuity from an insurance company. In return for handing over some or all of your pension savings, they promise to pay you a regular income, usually monthly, for the rest of your life.

This is most commonly done using funds built up in a defined contribution pension such as a personal pension or SIPP.

In the UK, buying an annuity used to be the default retirement option before the pension freedoms introduced by the Pension Schemes Act 2015. Today, it’s just one option among several.

How Does an Annuity Work?

Here’s a simple example:

• You retire at 67.

• You have £100,000 in your pension.

• You use that £100,000 to buy an annuity.

• The insurance company pays you, say, £6,000 a year for life.

The exact amount you receive depends on:

• Your age

• Your health

• Current interest rates

• Whether the income rises with inflation

• Whether it continues to a spouse after your death

Once purchased, most annuities cannot be changed or cancelled. That’s a crucial point. You’re effectively swapping flexibility for certainty.

Different Types of Annuity

There isn’t just one type. The main options include:

1. Lifetime Annuity

Pays you a guaranteed income for the rest of your life, no matter how long you live.

2. Fixed-Term Annuity

Pays income for a set number of years (e.g. 5 or 10).

3. Level Annuity

Pays the same income every year. Starts higher, but inflation erodes its value over time.

4. Inflation-Linked Annuity

Income rises each year, often in line with inflation. Starts lower but protects purchasing power.

5. Joint-Life Annuity

Continues paying income to a spouse or partner after your death.

6. Enhanced Annuity

If you have certain medical conditions or lifestyle factors (e.g. smoking), insurers may offer a higher income because of reduced life expectancy.

 The Advantages of Buying an Annuity

1. Guaranteed Income for Life

You cannot outlive your money. This removes longevity risk entirely.

2. Simplicity

Once set up, there’s nothing to manage. No investment decisions. No worrying about stock market falls.

3. Peace of Mind

For many retirees, knowing the bills are covered every month is invaluable.

 The Disadvantages

1. Irreversible Decision

Once you buy most annuities, you can’t change your mind.

2. Inflation Risk

A level annuity can lose real value over time.

3. Potentially Poor Value If You Die Early

If you die shortly after purchase (and haven’t chosen guarantees or joint-life options), the insurer keeps the remaining capital.

4. Less Flexibility

You lose access to your capital.

How Do Annuities Compare With Drawdown?

Since pension freedoms were introduced, many retirees instead choose flexible-access drawdown, keeping their money invested and withdrawing income as needed.

Drawdown offers:

• Flexibility

• Potential for investment growth

• Ability to pass on unused funds

But it also carries:

• Investment risk

• The possibility of running out of money

• Ongoing management and decision-making

An annuity, by contrast, provides certainty but little flexibility. Of course, there is nothing to stop you dividing your pension pot between both. You can also start off using drawdown and switch some or all of your pot to an annuity later, e.g once you reach your mid-70s.

 Who Should Consider Buying an Annuity?

An annuity isn’t right for everyone. But it may be suitable if:

You Want Certainty

If you value guaranteed income over flexibility, an annuity may suit you.

You Don’t Want Investment Risk

If market ups and downs worry you, locking in income could help you sleep better at night.

You Have No Other Guaranteed Income

If you don’t have a defined benefit (final salary) pension, an annuity can provide similar security.

You’re in Poor Health

An enhanced annuity may offer an attractive income rate.

You Want to Cover Essential Expenses

Some retirees use part of their pension to buy an annuity that covers core bills, leaving the rest invested for flexibility.

 Who Might Not Benefit?

You may want to think carefully if:

You have a strong desire to leave a financial legacy

You are comfortable managing investments

You have significant other guaranteed income already

You are relatively young and rates are less attractive

One Important Tip: Shop Around

You are not obliged to buy an annuity from your existing pension provider.

Using the “open market option” can significantly increase your income. Different insurers offer different rates, and enhanced terms are not always automatically applied.

This is one area where independent financial advice can genuinely add value.

How Much Income Could a £100,000 Annuity Buy You?

Example: 70-Year-Old Single Man (Standard Lifetime Annuity)

These are rough current illustrations – if you lock in a level annuity at age 70 with £100,000, you might expect around £8,000–£8,500 a year before tax as a starting point.

How Income Varies with Age

Age has a big impact because providers expect to pay income for fewer years the older you are:

What This Means in Practice

Let’s put those figures into context:

• If a 70-year-old buys a level lifetime annuity with £100,000, a payout of around £8,000 annually equates to about £667 per month before tax.

• Choosing escalation or inflation protection reduces the initial income but helps protect your spending power over time. For example, a rising income might start at ~£6,400 (with 3% annual increases).

• These examples are illustrative only – actual quotes vary by provider, postcode, health and product features. For a more precise quote, try an online calculator such as this independent one on the MoneyHelper website.

💡 Tip: Enhanced annuity rates may be higher if you have certain health conditions or lifestyle factors – always compare quotes across the market rather than accepting the first offer.

Quick Takeaways

• Older age = higher annuity income for the same pension pot.

• If you have health issues and/or an “unhealthy” lifestyle, you may get a better rate.

• Level income gives the highest starting payout but won’t keep pace with inflation.

• Inflation-linked or escalating options reduce initial income in exchange for rising payments.

• Shopping around is crucial – you don’t have to buy from your existing pension provider.

Final Thoughts

Annuities fell out of favour after pension freedoms were introduced, but rising interest rates in recent years have made them more competitive again.

They aren’t exciting. They aren’t flexible. But for the right person, at the right time in their life, they can provide something that’s hard to put a price on: certainty.

As always with retirement planning, the best solution may not be either/or. A blended approach – part annuity, part drawdown – can often provide the best of both worlds.

If you’re approaching retirement (or there already), it’s well worth understanding how annuities work before ruling them out entirely.

As always, if you have any comments or questions about this article, please do post them below. But note that I am not a qualified financial adviser and cannot give personalized advice. You should always do your own “due diligence” before making investment decisions and seek professional advice if in any doubt how best to proceed. Personally I strongly recommend getting independent professional advice and assistance before purchasing an annuity.