Passing on your pension
What is an annuity? Annuities &Retirement Income Options Explained
In this article you’ll find:
When you retire, one of the most important choices you ll make is how to turn your pension pot into a dependable income. For many people, annuities provide the security they’re looking for a steady payment, guaranteed for life or a fixed period, no matter what happens in the markets.
In essence, an annuity converts your pension savings into an income you can count on. You hand over part or all of your pension pot to an annuity provider, and in return, they agree to pay you a regular income monthly, quarterly, or annually. Once it s set up, your payments continue automatically, giving you peace of mind that your essentials are covered.
But not all annuities are built the same. Understanding the types available, their pros and cons, and how they fit into a broader retirement plan will help you make an informed, confident decision.
What is an annuity?
An annuity is a financial product designed to provide guaranteed income using your pension savings. You can choosean annuity that pays out for life or for a set number of years. It’s often used to cover core expenses – mortgage payments, bills, and everyday costs – so you’re not relying entirely on market-based income sources like drawdown or investments.
Once purchased, the annuity’s provider calculates your income based on several factors: age, health, the size of yourpension pot, and the options you choose, such as inflation protection or a joint-life benefit. The older you are or the more health conditions you disclose, the higher your rate may be. This is because the provider expects to make payments over a shorter time.
How do annuities work?
You can usually take up to 25% of your pension pot tax-free before using the rest to buy an annuity. The remaining amount is used to generate income, which is taxed in the same way as your salary. Your provider will then make regular payments directly into your account according to the terms of your contract
An annuity’s reliability makes it an attractive option for retirees who value stability. It takes market fluctuations out of the equation and replaces uncertainty with structure – a dependable foundation for the years ahead.
Different types of annuities
There are several types of annuities, each with different features and benefits. The right one for you depends on your personal circumstances, priorities, and outlook on risk. Below are the main options and how they work.
Lifetime annuity
A lifetime annuity pays a guaranteed income for as long as you live. It’s simple, predictable, and often used to cover day-today essentials. Many retirees combine it with drawdown or savings for additional flexibility
Pros:
- Income guaranteed for life – no matter how long you live.
- Options for joint-life cover, value protection, and inflation increases.
- Straightforward setup and minimal ongoing management.
Cons:
- Once purchased, an annuity can’t usually be changed or cancelled, and rates depend on market conditions at the time of purchase.
- Adding inflation protection or joint-life cover reduces the starting income.
- If you choose a level income, inflation may erode the spending power of your payments over time.
- Inflation may erode the spending power if a level income is taken.
Fixed-term annuity
A fixed-term annuity provides income for a set period, typically between five and ten years. At the end of the term, you receive a maturity amount that you can reinvest, use to buy another annuity, or take as cash.
Pros:
- Gives flexibility to review your options later in retirement.
- Useful for bridging income before state pension age.
- Allows access to potentially better rates in future.
Cons:
- Income stops at the end of the term unless renewed, and future annuity rates are uncertain.
- Less suited to those seeking long-term guarantees.
- If a level income is chosen, inflation may erode the spending power of your payments over the term.
- Inflation may erode the spending power if a level income is taken.
Enhanced annuity
Enhanced (or impaired-life) annuities offer higher rates to people with certain medical conditions or lifestyle factors, such as smoking or high blood pressure. These recognise shorter life expectancy in exchange for higher income.
Pros:
- Potentially higher income for eligible applicants.
- Reflects personal health and lifestyle for a fairer outcome.
Cons:
- Requires full medical disclosure to determine eligibility.
- Rates vary widely between providers – comparing quotes is essential.
Joint-life annuity
A joint-life annuity continues to pay an income to your spouse or partner after you pass away, usually at a chosen percentage of your income.
Pros:
- Provides financial security for a partner or spouse.
- Customisable continuation options (e.g., 50%, 66%, or 100%).
Cons:
- Lower starting income than single-life policies.
- Not always necessary if your partner has independent income.
Escalating annuity
An escalating annuity increases your income every year, either by a fixed rate or in line with inflation. That way, your income keeps pace with the rising cost of living
Pros:
- Helps protect income against inflation over time.
- Predictable, gradual increases provide budgeting confidence.
Cons:
- Lower initial income compared to level annuities.
- Inflation-linked versions cost more upfront.
Investment-linked annuity
An investment-linked annuity ties your income to investment performance. If markets perform well, your income may rise; if
they fall, it could reduce. It’s suited to retirees comfortable with some market exposure.
Pros:
- Potential for income growth over time.
- Often includes safety features like minimum payment floors.
Cons:
- Income may fall during market downturns.
- More complex than traditional annuities.
Comparing annuity types at a glance
The table below provides a quick comparison of the main annuity options available in the UK, highlighting how they differ in
duration, risk, and suitability. This can help you understand which type best aligns with your goals and circumstances.
As you can see, each option serves a slightly different purpose — and the right fit depends on your goals, risk tolerance,
and personal priorities.
| Annuity type | Income Duration | Risk Level | Inflation Protection | Flexibility | Typical Suitability |
|---|---|---|---|---|---|
| Lifetime | For Life | Low | Optional | Low | Guaranteed income seekers |
| Fixed-term | 5-10 Years | Low-Medium | Optional | Medium | Bridging income before state pension |
| Enhanced | For Life | Low | Optional | Low | Those with health or lifestyle factors |
| Joint-life | For life (with spouse continuation) | Low | Optional | Low | Couples seeking partner protection |
| Escalating | For Life | Low | High | Low | Those concerned about inflation |
| Investment-linked | Variable | Medium-High | Partial | Medium | Those comfortable with market exposure |
Example:
A 65-year-old with a £100,000 pension pot might receive around £6,300 per year from a standard lifetime annuity.
With certain medical disclosures, that same individual could qualify for an enhanced annuity paying roughly £7,100 per year.
If they opted for a 3% escalating income, their starting payments would fall to around £5,400, but would increase annually to help offset inflation.
Once you’ve decided which type of annuity fits, it’s worth understanding how taxation and additional guarantees can affect your income.
Tax rules and guarantees
You can normally take up to 25% of your pension tax-free before purchasing an annuity. The remaining 75% is used to generate income, which is taxed as regular income. You can add features such as guarantee periods or value protection to ensure some of your investment passes to loved ones if you die early. These reduce your starting income slightly but add peace of mind.
Annuity vs pension drawdown
An annuity provides stability, while drawdown offers flexibility. Choosing between them depends on your priorities. If you prefer guaranteed income and peace of mind, an annuity can be ideal. If you’d rather retain control over your investments and adjust income as needed, drawdown might be better. For many people, the best option is a blend – using an annuity to secure the essentials and drawdown for flexibility.
Weighing up the decision
Annuities aren’t perfect for everyone, but their strengths are clear for those seeking reliability. They remove investment uncertainty and provide structure, yet they come with trade-offs that should be understood.
Advantages:
- Certainty of income for life or a fixed period.
- Freedom from market volatility and investment decisions.
- Flexible options for inflation protection and joint-life cover.
Drawbacks:
- Limited flexibility once purchased.
- Inflation may erode fixed income over time.
- Rates can vary significantly between providers.
Expert insight: when to consider an annuity
Annuities tend to suit people who value stability and simplicity. They’re particularly useful for covering guaranteed expenses like mortgage payments, household bills, and daily living costs. If you prefer hands-off management and want to secure a lifelong income, an annuity can form the backbone of your retirement plan.
However, they don’t have to stand alone. Many clients use annuities alongside drawdown or savings. This combination offers both peace of mind and flexibility, ensuring you can meet essential needs while retaining access to liquid funds for unexpected costs.
FAQs about annuities
Ready to explore your options?
Your retirement income is too important to leave to chance. Whether you’re leaning toward an annuity, drawdown, or a mix
of both, professional guidance can help you make confident, informed decisions.
At My Pension Expert, our FCA-regulated advisers compare the whole market and tailor recommendations around your
goals, ensuring your retirement income works as hard as you do.
