Annuities explained

An annuity converts your savings into an annual pension, giving you a guaranteed income for life, or for a specified period.

What is an annuity?

An annuity converts your savings into an annual pension. If you’ve put money into a defined contribution pension scheme during your working life, you’ll have to decide what to do with the pension fund you’ve built up when you approach retirement age. One option is to buy a lifetime annuity (often just called an annuity). There are also other options available to you. 

In the video below, Paul Lewis, financial expert and presenter of BBC Radio 4's Moneybox, explains annuities in more detail.

Do you pay tax on annuities?

While you can take the first 25% of your pension pot tax-free, you'll get charged income tax on any additional money you take – and may need to consider the impact on your eligibility for state benefits or care services.

What are the different types of annuity?

Level annuities

A level annuity will pay you the same income each year. They have a higher starting income than an escalating annuity, but they can leave you vulnerable to inflation, which might make your annuity income worth less over time. Even low levels of inflation can significantly reduce your standard of living.

Escalating annuities

An escalating annuity will rise each year at a fixed rate. It may start lower than a level annuity, but the amount it pays you will increase at a fixed rate each year (for example, by 3%).

Inflation-linked annuities

An inflation-linked annuity will rise each year in line with the retail price index. This protects your annuity against inflation, but it will start at a much lower rate. You'll need to consider your particular circumstances, such as your health, whether you want to receive an annuity income over a short or long term, and whether you want to leave an income to a spouse or partner after your death.

Impaired or enhanced annuities

These pay out a higher income if your health or lifestyle may shorten your lifespan – for example, if you have an existing health condition or you smoke or are overweight. It's important to make sure that any provider you speak to asks you about your health so they can properly consider whether you're eligible for an impaired or enhanced annuity, as the income rates may be considerably better than other types of annuity.

Lifetime annuities

These will pay you an income for the rest of your life, unlike a short-term or fixed-term annuity.

Joint life annuities

These will pay an income to your spouse or partner after your death, but this is usually at a lower rate.

Short-term or fixed-term annuities

You can use part of your pension pot to buy an annuity that provides a short-term income. The rest of your pot is left invested, and you can still choose to buy a lifetime annuity when your short-term one expires. You might choose a short-term annuity if you don’t want to commit your pension fund to a life annuity as you believe rates might get better in the future.

Where can I buy an annuity?

It's a good idea to start by checking what your pension provider is offering, because they may still offer a higher payment rate than those available elsewhere.

But you don't have to buy your annuity from them – it's a good idea to shop around to find the deal that's right for you. This is known as the open market option.

Before buying an annuity it's a good idea to explore your other options for what you can do with your pension pot. Remember that you can only take the first 25% of your pension pot tax-free.

What should I do next?

Before you make any decisions about your pension, you should consider all your options:

1. Talk to your pension provider to find out about the options available to you.
2. Get independent advice – MoneyHelper has impartial information and helplines to speak to an adviser.
3. Be aware of pension scams – if a cold caller contacts you to give you pension advice, saying they have your details and have Government backing, then you should hang up, as this is likely to be a scam.