Pension Annuity

Thinking About a Pension Annuity? Here’s What You Need to Know

If you’ve built up savings in a defined contribution pension, one of the options open to you from age 55 (rising to 57 from April 2028) is to buy a pension annuity. It’s a way of turning your pension pot into a steady, predictable income—something many people value when they stop working and want financial peace of mind.

So, What Exactly Is an Annuity?

In simple terms, a pension annuity is a product you buy with your pension savings. In return, an annuity provider (usually an insurance company) agrees to pay you a regular income—either for life or for a fixed period of time. It’s a bit like swapping your pension pot for a guaranteed income stream.

Unlike investments, annuities aren’t affected by market ups and downs. Once set up, you’ll know exactly how much income you’re getting—and when. That certainty can make it easier to budget and enjoy retirement without worrying about what the markets are doing.

How Much Income Could You Get?

Your annuity income isn’t a flat rate—it depends on a few key factors:

• Your pension pot size – the larger your savings, the more income you’ll receive.
• Your age – older retirees often receive higher annuity rates.
• Your health and lifestyle – more on this below.
• The type of annuity you choose – lifetime vs fixed term, level vs increasing.
• Gilt yields – annuity rates are linked to government bond yields, which are influenced by the Bank of England’s base rate.

You can usually take up to 25% of your pension as a tax-free lump sum before buying your annuity. If you don’t, your full pot will go toward generating regular income—but that income will be taxed like any other earnings.

Lifetime or Fixed Term? You Decide

You’ve got options when it comes to how long your annuity pays out.

Lifetime annuity

This pays you a guaranteed income for the rest of your life. It offers long-term security, especially if you’re worried about running out of money in later years.

Fixed term annuity

Prefer flexibility? A fixed term annuity pays out for a set number of years—useful if, for example, you’re bridging the gap to when your State Pension kicks in. Some fixed term plans also return part of your fund at the end.

Want Your Income to Rise Over Time?

You can choose whether your annuity income stays the same each year or increases:

Level annuity

Pays the same amount every year. It’s simple, but inflation means your money may gradually lose spending power over time.

Escalating annuity

Starts lower but rises each year—either at a fixed rate or in line with inflation. It can help your income keep pace with the cost of living, especially if you’re planning for a long retirement.

When and How Will You Be Paid?

You can choose how often you want to receive your annuity payments—monthly, quarterly, half-yearly or annually. You can also decide whether you want the money in advance or in arrears.

Here’s the trade-off:

• Paid in arrears = slightly higher income overall
• Monthly payments = may suit you if you’re used to a monthly salary

What Happens to the Money When You Die?

Unless you choose to add death benefits, your annuity will stop when you die. But you can protect your loved ones if you want to.

Here are your options:

• Joint life annuity – keeps paying income to your spouse or another dependent after your death.
• Guarantee period – ensures payments continue for a set number of years, even if you pass away.
• Value protection – returns any unused portion of your pension fund to your beneficiary as a lump sum.

Bear in mind, adding death benefits will usually reduce the income you receive during your lifetime.

What About Tax?

• You can usually take 25% of your pension fund tax-free before buying an annuity.
• The rest of the income you receive is taxable, just like a salary.
• If you die before age 75, most annuity death benefits can be passed on tax-free.

If you die at 75 or older, your beneficiaries will pay tax on any income they receive.

Examples: What Could You Get?

Let’s take a look at what kind of income you might expect, based on annuity rates available in late 2022 for a 65-year-old:

(Remember: annuity rates change daily and can vary significantly based on your personal circumstances.)

Annuities vs Pension Drawdown

Annuities aren’t your only option. You can also leave your pension invested and draw money from it as and when you need it—this is known as flexi-access drawdown.

Here’s how the two compare at a glance:

Drawdown offers flexibility but comes with risk. An annuity offers certainty but less control.

Things to Think About Before Buying an Annuity

• Do you have other income sources?
  If you’ve got other pensions or income kicking in later, a fixed-term annuity might be a good way to fill the gap.
• How important is inflation protection?
  Will a level income cover your needs long-term, or would you prefer one that grows each year?
• Do you want to leave something for loved ones?
  If yes, you might want to add death benefits—but remember this could lower your own income.
• Do you want flexibility later on?
  A fixed-term annuity may let you reassess your options in a few years’ time.

What Does Martin Lewis Say?

MoneySavingExpert’s Martin Lewis is a big believer in shopping around for the best annuity deal. His advice?

“DON’T just get an annuity from your pension provider without checking elsewhere… you could be locking in many £1,000s less each year.”

He also reminds people that if you have health issues or smoke, you could get a higher income with an enhanced annuity—so it’s always worth disclosing your medical history.

Final Thoughts

Annuities can be a solid choice if you’re looking for reliable, predictable income in retirement. They won’t be right for everyone, but if peace of mind and budgeting certainty are high on your list, they’re well worth considering.

And remember—you don’t have to make this decision alone. Speaking to a regulated financial adviser can help ensure your retirement income is shaped around your needs, lifestyle, and goals.