An annuity is a financial product that converts your pension pot into a guaranteed income for life. You pay a lump sum to an insurance company, and they pay you a regular income — usually monthly — for as long as you live. It’s one of the simplest ways to turn savings into retirement income, but it’s not right for everyone.
How Annuities Work
You buy an annuity with some or all of your pension pot. The amount you receive depends on:
- Your age — older you are, higher the rate
- Your health — poor health can mean higher rates (enhanced annuities)
- Current annuity rates — set by the insurance company based on interest rates and life expectancy
- The type of annuity — level, escalating, or with guarantees
- Whether you include a spouse — joint life annuities pay less but cover your partner
Types of Annuities
Level Annuity
Pays the same amount every year for life. This gives you the highest initial income but doesn’t protect against inflation. If you live 20 years, your purchasing power will be significantly reduced by inflation.
Escalating (Inflation-Linked) Annuity
Your income increases each year — either by a fixed percentage (e.g. 3% per year) or in line with the Retail Prices Index (RPI). The starting income is lower, but it maintains its value over time.
Joint Life Annuity
Continues paying (usually at a reduced rate, often 50-67%) to your spouse or partner after you die. This is important if your partner relies on your pension income.
Enhanced Annuity
Pays a higher rate if you have a serious health condition or lifestyle factor that reduces your life expectancy. Common qualifying conditions include:
- Smoking-related illness
- Diabetes
- Heart disease
- High blood pressure
- Obesity
An enhanced annuity can pay 20-40% more than a standard rate.
Investment-Linked Annuity
Tied to the performance of investments rather than paying a guaranteed amount. These are riskier and less common — you might get more income if markets perform well, but less if they don’t.
Annuity Rates in 2026
Annuity rates fluctuate with interest rates and market conditions. As of mid-2026, a typical 65-year-old can expect:
| Annuity Type | Typical Rate | £200,000 Pot = Annual Income |
|---|---|---|
| Level (single life) | 6-7% | £12,000 - £14,000 |
| Escalating at 3% | 4.5-5.5% | £9,000 - £11,000 |
| Joint life (50%) | 5-6% | £10,000 - £12,000 |
| Enhanced ( smoker, 65) | 8-10% | £16,000 - £20,000 |
Worked Example: £200,000 Pot at 6%
| Item | Amount |
|---|---|
| Pension pot | £200,000 |
| Annuity rate | 6% |
| Annual income | £12,000 |
| Monthly income | £1,000 |
| Tax-free portion | 25% of each payment = £250/month |
| Taxable portion | 75% of each payment = £750/month |
If your total income (annuity plus State Pension) stays below the personal allowance of £12,570, you could pay very little or no income tax.
When Annuities Make Sense
Annuities are a good choice if:
- You want certainty — you know exactly how much you’ll receive every month for life
- You have poor health — enhanced rates can make annuities very competitive
- You have no dependants — you don’t need to preserve capital for inheritance
- You don’t want to manage investments — annuities are set-and-forget
- You’re risk-averse — you can’t tolerate your income falling if markets drop
When Drawdown Is Better
Drawdown may be more appropriate if:
- You want flexibility — take more income in some years, less in others
- You have other income sources — State Pension, savings, part-time work
- You want to leave money to family — remaining pot passes to beneficiaries
- You’re healthy and expect to live a long time — drawdown lets your pot grow
- You want to stay invested — keep your money in the market for potential growth
The Open Market Option (OMO)
When you buy an annuity, you don’t have to use the company that managed your pension. The Open Market Option means you can shop around for the best rate from any provider.
This is one of the most important steps in getting a good retirement income. Different providers offer different rates, and the difference can be thousands of pounds over your lifetime.
How to Shop Around
- Get quotes from multiple providers — use annuity comparison tools or ask a financial adviser
- Check for enhanced rates — tell every provider about your health conditions
- Compare like for like — make sure you’re comparing the same annuity type (level vs escalating, single vs joint)
- Don’t rush — you have time to get the best deal
- Consider financial advice — a regulated adviser can help you navigate the options
Annuity vs Drawdown: Quick Comparison
| Feature | Annuity | Drawdown |
|---|---|---|
| Income certainty | Guaranteed for life | Depends on investments |
| Flexibility | Fixed amount | Can change withdrawals |
| Investment risk | None | Yes — pot can fall |
| Inflation protection | Only with escalating type | Depends on growth |
| Inheritance | Usually stops on death | Remaining pot passes on |
| Complexity | Simple to set up | Requires ongoing management |
Key Takeaways
- An annuities convert your pension pot into guaranteed income for life
- Level annuities give the highest starting income; escalating annuities protect against inflation
- Enhanced annuities pay more if you have health conditions
- Use the Open Market Option to shop around — don’t just accept your pension provider’s offer
- Annuities suit people who want certainty; drawdown suits those who want flexibility