If you’re approaching retirement and want guaranteed income for life, a pension annuity could offer you financial security and peace of mind. Here, we’ll cover everything you need to know about how annuities work, the rules, how annuity payouts are calculated, and where to get expert support.
What is a pension annuity?
An annuity is a financial product that converts your pension savings into a predefined level of income (for life or a fixed period). It’s a popular retirement income option for those who want a degree of certainty and don’t want to worry about investment risks or managing their pension over time.
An annuity is typically bought using money from a defined contribution (DC) pension pot once you retire. The amount of income you receive depends on factors like your age, health, the size of your pot, and the type of annuity you choose.
How does it work?
When you retire (or any time from age 55, rising to 57 from 2028), you can take 25% of your pension as a tax-free lump sum. The remaining funds can be used to buy an annuity. Alternatively, you could use your entire pot to purchase an annuity.
Once bought, the annuity provider pays you a regular income, either monthly, quarterly, or annually, depending on your preference. This income is taxable as regular income under PAYE. Still, it is guaranteed for life or a fixed term, regardless of fluctuations in investments (unless you purchase an investment-linked product).
You can’t change or cancel your annuity once it’s been set up, so it’s essential to understand your options and find the best deal.
Types of annuity pensions
There are several types of annuity products available in the UK. Choosing the right one depends on your income needs, health, and whether you want to financially protect your loved ones. Here are the main types of pension annuities:
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Lifetime annuity: Pays a guaranteed income for life. You can choose a single-life annuity (just for you) or a joint-life annuity (which continues for a spouse or partner after your death).
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Fixed-term annuity: Provides a guaranteed income for a set number of years (usually between 1 and 40), after which you may receive a lump sum or the option to buy another retirement product.
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Enhanced annuity: Offers a higher income if you have certain health conditions, are a smoker, or have a shorter life expectancy.
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Inflation-linked annuity: Income starts lower but increases each year in line with inflation (CPI or RPI measure), helping to protect your spending power over time.
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Escalating annuity: Rises at a fixed rate annually (e.g. 3% per year), regardless of actual inflation levels.
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Investment-linked annuity: Sometimes called a ‘variable’ or ‘with-profits’ annuity, the income you get depends on the performance of the underlying investments.
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Deferred annuity: This option allows you to postpone the start date of your annuity, which can be beneficial for tax planning purposes.
Rules and requirements
Here are the key rules to be aware of if you’re considering a pension annuity:
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You must be at least 55 to buy an annuity (rising to 57 from 2028).
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You can usually take up to 25% of your pension tax-free, known as the Pension Commencement Lump Sum (PCLS).
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Your pot can be used to purchase the annuity, and the income is taxable under the standard PAYE system (you don’t have to take the tax-free lump sum).
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Annuities are only available for DC pensions (unless you transfer out of a defined benefit (DB) scheme, which usually requires regulated advice).
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Once set up, annuities cannot be changed, cancelled, or reversed, so it's essential to compare rates and features before you commit.
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You’re free to shop around for the best deal; you don’t have to buy your annuity from your current pension provider.
How annuity rates and payouts are calculated
Your annuity income will depend on several factors. Here’s what typically goes into calculating your quote and rate:
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Pension pot size: The more you have saved to purchase an annuity, the higher your potential income.
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Age: Older pensioners usually receive higher annuity rates, as payments are expected to be made over a shorter period.
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Health and lifestyle: Smokers and those with health issues may qualify for enhanced annuities offering better income (basically the opposite of how life insurance quotes work).
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Type of annuity: Single or joint life, level or escalating - all of these influence how much retirement income you’ll get.
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Interest rates and investments: The current economy and market can affect how much annuity providers can afford to pay. Higher interest rates typically result in better annuity rates, but poor investment performance can be a drag.
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Guaranteed period or value protection: Adding these options can reduce your initial income, but provide a level of security for your loved ones.
Annuity rates and the way they’re calculated will vary between providers and change frequently, so it’s worth speaking to an adviser to compare all your current options.
Do you need a pension adviser to buy an annuity?
It’s not a requirement, but it’s incredibly worthwhile. Guidance from a financial adviser when buying an annuity can result in a better deal and more income from your pension savings.
Professional guidance can be invaluable, especially given the permanence and complexity of these decisions. An independent pensions adviser can help you:
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Shop around and compare annuity rates across the whole market.
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Evaluate if an annuity is right for you or whether an alternative way of accessing your pension is more suitable.
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Understand how to combine annuities with other strategies (like pension drawdown).
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Access enhanced rates with specialist firms if you qualify due to health or lifestyle.
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Choose suitable protection features for your partner or family for long-term planning.
If you’re unsure how much annuity income you could get or how it fits in with your broader retirement plan, advice can provide peace of mind and help avoid any costly mistakes.
Get independent pension advice today
Alternative options to consider
Annuities provide a degree of certainty, but they’re not the only way to access your pension pot. Depending on your goals, you may want to consider one or more of these alternatives:
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Pension drawdown: Offers flexible access to your pot while keeping the rest invested. You choose how much to withdraw and when, but your income isn’t guaranteed. It’s most suitable for those comfortable managing investments or working with an adviser.
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Uncrystallised Funds Pension Lump Sum (UFPLS): This allows you to take lump sums directly from your pension, with the first 25% being tax-free and the rest taxed as regular income. Suitable for occasional withdrawals or one-off needs.
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Remain invested: If you don’t need the money yet, you can leave your pension invested. This could lead to continued growth and preserve your lump sum allowance for later. It might potentially mean you can buy a better annuity deal down the line.
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Cash in your whole pension: You can withdraw your entire pension pot at once, which is usually suitable only for smaller pots. Bear in mind, this may result in a substantial tax burden and restrict your future pension contributions.
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Combine strategies: Some retirees choose to buy an annuity to cover essential expenses, while using drawdown for flexibility and growth. This hybrid approach offers both security and adaptability. An adviser can help you create a personalised plan tailored to your specific needs.
Why choose Money Helpdesk for your annuity?
Finding the right financial advice for your pension annuity can feel overwhelming, no matter what stage of life you're at. Your retirement goals, pension pots, and personal circumstances are all unique. Getting tailored guidance can make a big difference.
At Money Helpdesk, our expert advisers will help you gain some clarity and confidence with your pension. Whether you want to compare annuity quotes, see if you qualify for enhanced rates, or check whether an annuity is right for you, they can help.
Here are some more of the reasons why people trust us to help them with pension annuities:
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Our advisers are independent, giving you the widest options
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Free initial pension review, with no obligation to go further
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Fully qualified, FCA-regulated financial planners
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Access to annuity specialists offering the best rates
Ready for a free, no-obligation initial pension annuity review? You can get started here.
FAQs
It depends on the type of annuity you choose. If you bought a single-life annuity with no guarantees, payments stop when you die. But if you opted for a joint-life, guarantee period, or value protection, your spouse or estate may receive ongoing income or a lump sum.