10 June 2024

Many people like you are looking for reliable ways of funding their later years.

Perhaps you:

  • want to make sure the bills are covered for the foreseeable future
  • would like to fund a dream trip or a favourite hobby
  • just need to top up your income if you switch to working part time.

Whatever your goals, if a guaranteed income will help you achieve them, a pension annuity can help. But how do annuities work?

What is annuity income?

A standard annuity pays you a guaranteed income for the rest of your life, no matter how long you live. Your payments can be:

  • monthly
  • quarterly
  • half-yearly
  • annual.

You can also get fixed-term or temporary annuities that pay a guaranteed amount for a set period.

The amount of income you get can depend on:

  • How much of your pension pot you spend
  • Which features you choose when you set up your annuity
  • Your health and lifestyle.

And you can set your annuity up to keep paying out to your spouse or partner, so they’re taken care of if you die before them. You can learn more about how this works in our article, 'What happens to an annuity when you die?'

We can put together a personalised annuity quote for you, which will tell you if you could get a better rate elsewhere. Or you can try our annuity calculator to see what kind of income you could receive from your pension pot size.

How do annuities work?

A pension annuity (to give it its full name, though it’s usually just called an annuity) is a product that you can buy once you’re 55 or older (increasing to 57 from 2028). It gives you a guaranteed income unlike, for example, drawdown, which can run out. So it:

  • is a very low-risk way of funding your retirement
  • can be a big help with your planning and budgeting.

“One of the great pluses of financial planning is that it can help you deal with the unexpected in later life,” says Lorna Shah, Managing Director, Legal & General, Retail Retirement. “Of course there are surprises at every stage of life. But as you get older it can be harder to make changes or corrections to your finances. A bit of careful planning can help you be ready for that.”

With an annuity, you:

  • will have a clear, specific picture of your retirement income
  • can make sure you’re saving enough for your ideal retirement lifestyle.

You can learn more about funding your retirement on the Retirement Living Standards website

Ready to get an annuity quote?

We can put together a personalised annuity quote for you, which will tell you if you could get a better rate elsewhere. 

What are fixed term or temporary annuities?

Fixed term annuities or temporary annuities are terms often used to describe retirement income products that pay a guaranteed income for a set period of time, rather than for the rest of your life. They’re usually set up to run for between 3 and 25 years.

People choose them for their combination of security and flexibility. Like an annuity that lasts for the rest of your life, they give you a guaranteed income.

But because you only receive that income for a set period, you’re free to look at other options when they end. That can make them a very useful bridge, tiding you over until another source of income (like your State Pension) kicks in. Depending on the options you choose, you can also opt to have a lump sum payment when your product comes to an end, and if your circumstances change you might be able to cash in or transfer your product.

What’s the difference between an annuity and a pension? 

Your pension pot is the savings you build up over your working life. When you reach retirement age, you decide how you’d like to use it to support your chosen lifestyle.

An annuity is a product you can buy with your pension pot. It’s a way of turning that pot into a secure income that will last for the rest of your life, much like your State Pension.

So it’s not a case of annuity vs pension.

Annuities don’t compete with pensions, they're something you can buy with your pension pot. But when people talk about their pensions, they’re often describing the income they can buy with their pot, as much as the pot itself.

How do annuity rates work?

Your provider will probably set your annuity rate as an annual percentage of the amount you spend on your annuity. So for example, if after taking your tax-free cash:

  • you have £100,000 to buy your annuity


  • they offer you an annuity rate of 5%

You’ll get:

  • £5,000 a year back from them.

It's certainly worth considering now. As at June 2024, our annuity rates are 23% higher than they were in June 2022*.

They’ll take several factors into account when they work out your annuity rate, including:

  • Your age
  • Your postcode
  • Your health and lifestyle.

Certain health issues can lead to a better rate – you can find out more about that in our article on enhanced annuities. Different providers will be more or less optimistic about the future, which will affect how much they offer you.

Any benefits you choose can also make a difference to how much you get. And finally, when you’re setting up your annuity you’ll need to make sure you get the right balance of income and benefits. 

*Based on our average annuity rates at June 2024 for ages 65-80 with a £40K pension pot, 5 year guarantee period and 50% dependant’s pension. 

Can your annuity income change?

Depending on the provider and product you choose, you can set up your income to:

  • stay the same for the life of the annuity
  • rise in line with inflation
  • rise at a rate you agree with your provider.

Having a guaranteed income can help you with your retirement planning and budgeting. A rising income can help you cover any costs that inflation pushes up in years to come.

But once you’ve set your annuity up:

  • you can’t make any changes to it
  • it has no cash-in value
  • you can’t sell it, transfer it to someone else or take lump sums out of it.

And depending on how long you live and the options you choose, you might get back less than you pay into it.

So you’ll need to make sure that you choose:

  • The right kind of annuity
  • The right combination of income and benefits.

That can be a difficult choice! If you need help making it, we recommend a chat with the Government’s free guidance service Pension Wise. Or you could find a financial adviser. You can find out how to do that at the end of this article.

Is annuity income taxable?

Yes, annuity income is taxable.

  • HMRC treats your annuity income like any other taxable income, including your State Pension.
  • If your total income, including the money you receive from your annuity, goes above your personal allowance, it’s taxable.
  • The amount of tax you pay will depend on your personal circumstances and may change based on your income tax rate.

How do annuities work at death? 

Your income payments will stop when you die. There are options to make sure your loved ones are looked after though. You can:

  • Have some or all of your income paid to them. That can continue either for a set period of time or until they reach the end of their own life.
  • Protect a percentage of the money you use to buy your annuity – for example, 25%, 50% or 100% of it. Your provider will pay out a lump sum based on that amount, less however much they’ve already paid you.

If you die before you’re 75 and any money starts going to a loved one, they won’t have to pay tax on it.

If you die when you’re 75 or older, they’ll have to pay tax at their personal rate. In either case it could affect any means-tested benefits they’re receiving.

What should I do next?

We hope that’s helped you understand how annuities work.

Now we recommend shopping around to find the right product for you, whether that’s one of ours or someone else’s. Your pension provider might have an annuity of their own, though you don’t have to buy it. Other providers will offer different and possibly better products and rates.  

If you’re nearing retirement and think an annuity might be right for you:

  • it’s a good idea to make an appointment with Pension Wise. It’s a free government guidance service from MoneyHelper, especially for over 50s
  • if you need a financial adviser, the Unbiased website will help you find one. We also offer a Retirement Advice service for over 55s
  • we’d be very happy to answer your questions ourselves – just call us on 0800 048 2446 or visit our pension annuity page for more information.

Lines open Monday to Friday 9am to 5pm. We may record and monitor calls.

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