An annuity is a financial product that converts your pension pot into a guaranteed income for life. You pay a lump sum to an insurance company, and they pay you a regular income — usually monthly — for as long as you live. It is one of the simplest ways to turn savings into retirement income, but it is not right for everyone.
For many people the appeal is obvious: the worry that you might run out of money late in life, however long you live, disappears entirely. Every month an agreed amount lands in your account, and you never have to decide what to sell, when to draw down, or how to manage a portfolio. That certainty is exactly what a lot of retirees are paying for. But annuities also trade away flexibility and control, and they lock up your capital, so the decision deserves more thought than simply accepting the first quote that arrives in the post.
How Annuities Work
You buy an annuity with some or all of your pension pot. The amount you receive depends on a handful of factors that the insurance company weighs up when it prices your contract:
- Your age — the older you are, the higher the rate, because the insurer expects to pay out over a shorter period
- Your health — poor health can mean higher rates (these are known as enhanced annuities)
- Current annuity rates — set by the insurance company based on interest rates and life expectancy
- The type of annuity — level, escalating, or with guarantees
- Whether you include a spouse — joint life annuities pay less but cover your partner
At its core, an annuity is an insurance product rather than an investment. You are pooling your life expectancy risk with thousands of other people: those who live longer are, in effect, subsidised by those who do not. That is why no individual has to worry about outliving their money — the risk sits with the insurer, not with you.
Types of Annuities
Not all annuities are the same, and the type you choose has a big influence on both your starting income and how that income behaves over time.
Level Annuity
A level annuity pays the same amount every year for life. It gives you the highest initial income but does not protect against inflation. If you live 20 years, your purchasing power will be significantly reduced by inflation, because the same nominal amount will buy less each year.
Escalating (Inflation-Linked) Annuity
An escalating annuity increases your income each year — either by a fixed percentage (for example 3% per year) or in line with the Retail Prices Index (RPI). The starting income is lower, but the payments maintain their value over time, which can matter a great deal over a long retirement.
Joint Life Annuity
A joint life annuity continues paying — usually at a reduced rate, often 50-67% — to your spouse or partner after you die. This is important if your partner relies on your pension income, because a single life annuity would normally stop the payments entirely when you pass away.
Enhanced Annuity
An enhanced annuity pays a higher rate if you have a serious health condition or a lifestyle factor that reduces your life expectancy. Common qualifying conditions include:
- Smoking-related illness
- Diabetes
- Heart disease
- High blood pressure
- Obesity
An enhanced annuity can pay 20-40% more than a standard rate, which is why it is always worth telling every provider about any relevant health details rather than assuming they do not apply to you.
Investment-Linked Annuity
An investment-linked annuity is tied to the performance of investments rather than paying a guaranteed amount. It is riskier and less common — you might get more income if markets perform well, but less if they do not.
Annuity Rates in 2026
Annuity rates fluctuate with interest rates and market conditions. As of mid-2026, a typical 65-year-old can expect rough rates in the following ranges:
| Annuity Type | Typical Rate | £200,000 Pot = Annual Income |
|---|---|---|
| Level (single life) | 6-7% | £12,000 - £14,000 |
| Escalating at 3% | 4.5-5.5% | £9,000 - £11,000 |
| Joint life (50%) | 5-6% | £10,000 - £12,000 |
| Enhanced (smoker, 65) | 8-10% | £16,000 - £20,000 |
These are indicative figures rather than guarantees. Rates move with the wider economy, so the only way to know what is on offer on any given day is to get fresh quotes from several providers.
Worked Example: £200,000 Pot at 6%
| Item | Amount |
|---|---|
| Pension pot | £200,000 |
| Annuity rate | 6% |
| Annual income | £12,000 |
| Monthly income | £1,000 |
| Tax-free portion | 25% of each payment = £250/month |
| Taxable portion | 75% of each payment = £750/month |
If your total income (annuity plus State Pension) stays below the personal allowance of £12,570, you could pay very little or no income tax.
When Annuities Make Sense
Annuities are a good choice if:
- You want certainty — you know exactly how much you will receive every month for life
- You have poor health — enhanced rates can make annuities very competitive
- You have no dependants — you do not need to preserve capital for inheritance
- You do not want to manage investments — annuities are set-and-forget
- You are risk-averse — you cannot tolerate your income falling if markets drop
For someone who values peace of mind above flexibility, an annuity has a lot going for it. The trade-off is that you hand over control of a large sum of money and cannot easily get it back.
When Drawdown Is Better
Drawdown may be more appropriate if:
- You want flexibility — take more income in some years, less in others
- You have other income sources — State Pension, savings, part-time work
- You want to leave money to family — the remaining pot passes to beneficiaries
- You are healthy and expect to live a long time — drawdown lets your pot grow
- You want to stay invested — keep your money in the market for potential growth
Drawdown keeps your pension invested, so it can grow, but that also means it can fall. You take on the investment risk yourself, and you are responsible for managing how much you withdraw. Many people take a middle path, using an annuity to cover essential bills and keeping the rest in drawdown for flexibility.
The Open Market Option (OMO)
When you buy an annuity, you do not have to use the company that managed your pension. The Open Market Option means you can shop around for the best rate from any provider.
This is one of the most important steps in getting a good retirement income. Different providers offer different rates, and the difference can be worth thousands of pounds over your lifetime, because a slightly higher rate applies to every payment you receive for the rest of your life.
How to Shop Around
- Get quotes from multiple providers — use annuity comparison tools or ask a financial adviser
- Check for enhanced rates — tell every provider about your health conditions
- Compare like for like — make sure you are comparing the same annuity type (level vs escalating, single vs joint)
- Do not rush — you have time to get the best deal
- Consider financial advice — a regulated adviser can help you navigate the options
Annuity vs Drawdown: Quick Comparison
| Feature | Annuity | Drawdown |
|---|---|---|
| Income certainty | Guaranteed for life | Depends on investments |
| Flexibility | Fixed amount | Can change withdrawals |
| Investment risk | None | Yes — pot can fall |
| Inflation protection | Only with escalating type | Depends on growth |
| Inheritance | Usually stops on death | Remaining pot passes on |
| Complexity | Simple to set up | Requires ongoing management |
A Final Word
Choosing between an annuity and drawdown is one of the biggest financial decisions you will make, and there is rarely a single right answer. The best approach depends on your health, your other income, whether you have dependants, and how comfortable you are with risk. What matters most is that you understand the trade-offs and, critically, that you shop around rather than accepting whatever your existing pension provider offers first. A little time spent comparing quotes — and being open about your health — can make a difference of thousands of pounds over the course of your retirement.