A pension annuity is an income you buy from an insurer with money from a defined contribution pension, paid for life or for a fixed number of years.
It is also a set of choices, nearly all made on the day you buy and hard to change later: how much of your pot to use, whether the income rises, and whether it carries on for a partner. This guide explains how a pension annuity works in the UK and the main types.
If you are 50 or over and have a defined contribution pension, Pension Wise, from MoneyHelper, offers a free appointment on your options, and MoneyHelper presents the service as impartial and government-backed. If you would like someone to look at your own position and say which kind of annuity, if any, fits it, fill in the form on this page and we will put you in touch with an FCA-authorised adviser. The enquiry is free and takes a minute or two.
What a pension annuity is, in plain terms
An annuity is a contract with an insurance company. You hand over money from your pension, and the insurer promises to pay you an income on the terms in the contract. MoneyHelper's definition:
An annuity lets you convert some or all of the money in your defined contribution pension into guaranteed taxable income, either for: the rest of your life – called a lifetime annuity a fixed amount of time, such as five or ten years – called a fixed-term annuity.
— MoneyHelper, Take your pension as a guaranteed income: annuities explained, read via the Internet Archive
Three words in that sentence carry the meaning. Defined contribution: an annuity is bought from a pot built up from contributions and investment growth, such as a personal pension, a SIPP or most modern workplace pensions; HMRC's Pensions Tax Manual says a lifetime annuity "can only be purchased from a money purchase arrangement", money purchase being the tax term for defined contribution. Guaranteed: the insurer has promised the income, so it no longer depends on how investments perform. Taxable: annuity income is pension income and is taxed as income through PAYE.
So a pension and an annuity are not alternatives. The pension is the pot you saved; the annuity is one thing you can do with it. GOV.UK lists it beside the other routes for a personal pension: taking cash, investing the pot for an adjustable income (pension drawdown), or buying a guaranteed income for life, which it says is sometimes known as an annuity. Your defined contribution options at retirement sets them side by side.
A final salary pension works differently. HMRC's manual says a scheme pension is the only way a defined benefits arrangement (or a collective money purchase arrangement) can provide its members with a pension benefit, so the scheme pays the income itself and the choices below are not yours to make there.
Once bought, an annuity is hard to undo. MoneyHelper says that after the cooling-off period closes, a change of mind is typically not possible. See can I cash in my annuity.
How an annuity turns your pot into income
The path is broadly the same with any provider:
- Decide how much of the pot to use. Not all of it has to go, nor all at once. Up to 25% can be taken first as tax-free cash, within the limits in the next step; the remainder can buy an annuity straight away, or stay invested with some or all of it used to buy one at the same time or later. Several pensions can each be treated differently.
- Decide about the tax-free lump sum. GOV.UK says tax-free cash is usually capped at 25% of the pot and at a maximum of £268,275, more for people with a protected allowance. The more you take as cash, the less is left to provide an income later. See our guide to the tax-free lump sum.
- Check for a guaranteed annuity rate. Some older policies promise one, and MoneyHelper says it can guarantee more income than you could buy elsewhere. See guaranteed annuity rates.
- Compare insurers. GOV.UK says the insurer need not be your pension provider (see how to compare annuity rates). You can compare through a comparison tool, quotes you gather yourself, or by paying a regulated adviser to recommend a provider and product.
- Answer health and lifestyle questions. This is the underwriting. The insurer asks medical questions to estimate your life expectancy, and conditions such as diabetes or high blood pressure, smoking, some past jobs and where you live can lead to a higher offer.
- Choose the features, covered below, and use the cooling-off period if you need it. Most annuities, MoneyHelper says, carry a 30-day window in which you can cancel and get your money back; afterwards an annuity cannot be cancelled.
How the payments arrive
MoneyHelper says you can usually be paid "monthly once, twice or four times a year". Paid in advance, the first payment comes as soon as the annuity is set up; paid in arrears, it comes at the end of the first period, so "the first payment of a monthly annuity paid in arrears would be one month after you set it up."
Tax comes off first. HMRC's manual says lifetime annuity income "is taxable as 'pension income' on the recipient through PAYE", and GOV.UK says the provider sends a P60 after each tax year. MoneyHelper warns that a provider might use a temporary or emergency tax code for your first payment; overpaid tax can be reclaimed. More in how pensions are taxed.
What decides how much income an annuity pays
GOV.UK says the amount reflects how long the insurer expects to be paying you, taking into account your age and gender, the size of your pot, interest rates and sometimes your health. MoneyHelper adds your own choices: how much you convert, lifetime or fixed term, whether the income rises, and where you plan to live.
Older buyers tend to be offered more income per pound, because the insurer expects to pay for fewer years. A health condition that shortens life expectancy tends to raise the offer, the idea behind enhanced annuities. Each extra feature, such as a rising income, a partner's pension or a guarantee, tends to lower the starting income. Interest rates move the market too; see where annuity rates are heading.
An annuity rate is the yearly income as a share of the money put in. MoneyHelper illustrates it with arithmetic rather than a quote from any insurer: on a £100,000 pot, a 5% rate gives £5,000 a year and 6% gives £6,000. That is the whole annuity calculation: rate times purchase price gives the yearly income before tax. What a given age and pot might be offered is in how much annuity income a pot buys, and the long view in UK annuity rates through history.
Because the answer turns on your age, health and pot, two people with the same savings can be offered quite different incomes. To have your figures looked at alongside your other pensions and State Pension, use the form on this page to ask for a conversation with an FCA-authorised adviser.
The main types of annuity in the UK
Most annuity names describe a feature rather than a separate product, so one annuity can be lifetime, escalating, enhanced and joint life all at once.
| Name | Question it answers | What it means |
|---|---|---|
| Lifetime | How long does it pay? | For the rest of your life. |
| Fixed-term | How long does it pay? | For an agreed period, often with a lump sum at the end. |
| Level | Does the income change? | The same amount every year. |
| Escalating | Does the income change? | Rises each year by a set rate or with inflation. |
| Enhanced | Does my health count? | More income where health or lifestyle is expected to shorten life. |
| Joint life | Who does it cover? | Carries on paying a partner or dependant after you die. |
| Investment-linked | Is the income fixed? | Tied to investments, so it can fall as well as rise. |
Lifetime annuities. HMRC's manual calls a lifetime annuity "a means of turning pension capital into an income that lasts for all of a pensioner's retirement". It must be "payable for the member's life", or until a guarantee period ends if that is later.
Fixed-term annuities pay for "an agreed period between 1 and 40 years", according to MoneyHelper, and can end with "a payment when the annuity ends – called a maturity amount", agreed at the start. One tax difference matters to anyone still paying into a pension. MoneyHelper's summary is that the MPAA is triggered by a fixed-term annuity but not by a lifetime one, though HMRC's manual also counts a lifetime annuity whose terms allow the income to fall as a trigger event. The money purchase annual allowance cuts the tax-relieved limit on contributions from £60,000 to £10,000, the same summary adds. See how a fixed-term annuity works.
Level or escalating. An escalating income rises each year by a fixed percentage or with inflation (sometimes capped), and the price is usually a lower starting income than a level annuity would give. MoneyHelper's worked example, and the other points to weigh, are in inflation-linked annuities.
Enhanced annuities are lifetime annuities priced on fuller health information, which MoneyHelper says "is often called an impaired life or enhanced annuity". Who qualifies is in qualifying for an enhanced annuity.
Joint life annuities continue paying a dependant or nominee after your death; HMRC's manual describes this as a further annuity for dependants or nominees. You choose the share that continues, and the starting income is usually lower. See joint life annuities.
Investment-linked and flexible annuities. HMRC's manual says an annuity bought on or after 6 April 2015 "can decrease in any circumstances as set out in the contract", which allows income linked to investments. That gives up part of the certainty: investments can fall in value as well as rise, so the income can drop and you may get back less than you put in.
Three related products have their own pages: the deferred annuity, which starts paying later; the purchased life annuity, bought with savings rather than a pension; and the care fees annuity.
What happens when you die: guarantees and protection
A plain single life annuity stops at death, even a year after purchase; long lives are paid for by short ones. A joint life annuity, above, is one way round that. Two optional protections are another: a guarantee period, under which payments carry on to the end of a set term if you die before it ends, and value protection, which pays out a lump sum if what the annuity has paid by your death is less than it cost. MoneyHelper says protections have to be chosen when the annuity is first taken out and that each one usually means a lower income, since the income is more likely to be paid for longer; HMRC's manual says value protection is costed into the annuity price. A joint life policy pays nothing if the dependant dies before you. What happens to an annuity when you die explains how each protection works and how survivors are taxed; guarantee periods and value protection and annuity overlap go further.
What to weigh before buying an annuity
Whether an annuity is a good idea is personal; is an annuity worth it sets out the pros and cons.
Certainty against flexibility. An annuity brings certainty about how much you will get and how often. The other side: the money is committed, the terms are fixed, and a level income buys less as prices rise. Annuity or drawdown compares the two.
It need not be all or nothing. Some people buy an annuity to cover essential bills and keep the rest invested; money left invested can still fall in value. Retirement, MoneyHelper reminds readers, "is often over 20 years".
Tax and benefits. Annuity income is added to your other income, including the State Pension, for tax. MoneyHelper also warns that extra annuity income could affect benefits you are entitled to claim, which matters to anyone on or near means-tested help such as Pension Credit.
If the insurer fails. The FSCS says it can generally protect pensions from UK-regulated insurers where the plan counts as a contract of long-term insurance, and gives an annuity as a common example. Where it can pay, it covers the pension at 100%, with no upper cap. It cannot confirm in advance whether a given plan qualifies, so ask the provider. See if an annuity provider goes bust.
Pressure is a warning sign. The FCA's pension scams guidance says to hang up on a cold call about your pension, because it is illegal and probably a scam. MoneyHelper likewise warns against buying an annuity on the strength of an unsolicited call, visit, email or text.
The choices interact: a guarantee and a joint life pension overlap, an enhanced quote changes what is affordable, and the lump sum changes what is left to buy income with. To have them weighed together for your circumstances, fill in the form on this page and an FCA-authorised adviser can go through them with you.
Pension annuity questions people ask
Is an annuity paid for life?
A lifetime annuity is, plus any unexpired guarantee period. A fixed-term annuity pays only for the agreed term, which MoneyHelper puts at 1 to 40 years. So not all annuities pay for life.
Is annuity income guaranteed, and is it safe?
A conventional annuity's income is the insurer's promise and does not depend on investment performance; an investment-linked annuity's income can fall. If a UK-regulated insurer fails, FSCS protection generally applies to annuities, as described above.
Does annuity income count as pension income?
Yes. HMRC treats it as pension income, taxed through PAYE before it reaches you.
Can I add to an existing annuity?
An annuity's features are fixed at purchase. MoneyHelper describes using part of a pot now and more "at a later date", that is, a further annuity rather than an addition to the first. Ask the provider what its contract allows.
Is a guarantee period or capital-back option worth having?
It depends on whether you want something to pass on if you die early and how much starting income you will give up for it. The trade-offs are set out in guarantee periods and value protection.
How does a living annuity work?
If you mean a pension that stays invested while it pays an adjustable income, the UK arrangement is drawdown, whose value can fall as well as rise.
When can I buy an annuity?
From your scheme's minimum pension age, normally 55, with earlier access only on ill-health grounds or hold a protected pension age; HMRC's policy paper says the normal minimum pension age rises to 57 from 6 April 2028. See the best age to buy an annuity.
Do I need an adviser to buy an annuity?
No. You can compare quotes yourself or get free guidance from Pension Wise; an adviser, usually paid, can recommend a product. See free annuity advice.
Your next step
A pension annuity swaps savings for an income on terms fixed the day you buy: how much to convert, for how long, whether it rises, who it covers, and whether your health earns a better offer. Pension Wise can explain the options free. If you would rather an FCA-authorised adviser looked at those decisions against your whole position, fill in the form on this page and we will pass your enquiry on.
Sources: MoneyHelper, annuities explained (archived copy); GOV.UK, Personal pensions; GOV.UK, Tax when you get a pension; HMRC, Pensions Tax Manual, lifetime annuity and MPAA trigger events; HMRC, Increasing normal minimum pension age; FCA, Pension scams; FSCS, Pensions.