Pension Guide: Annuities Explained UK — How They Work, Types, Rates and Whether One Is Right for You

An annuity is a contract between you and an insurance company. According to GOV.UK pension guidance, you pay them a lump sum from your pension pot (the 'purchase price'), and they pay you a regular income for the rest of your life. Once set up, the terms are fixed — you cannot change the type of annuity, adjust the income, or get your money back.

You can buy an annuity from age 55 (rising to 57 from 6 April 2028). You don't have to use your entire pension pot — you can use part of it for an annuity and keep the rest in drawdown or as a cash lump sum. You can also take your 25% tax-free lump sum (pension commencement lump sum) before purchasing the annuity.

The amount of income you receive depends on several factors:

• Your age: Older purchasers get higher rates because the insurance company expects to pay out for fewer years
• The size of your pension pot: A larger purchase price means higher income
• Gilt yields: Annuity rates are closely linked to UK government bond (gilt) yields, particularly 15-year gilts
• Your health: If you have health conditions or lifestyle factors (such as smoking), you may qualify for an enhanced annuity with higher payments
• The type of annuity: Features like inflation protection, joint life cover, or guarantee periods all reduce the starting income

Annuity income is treated as earned income for tax purposes. It's added to your other income and taxed at your marginal rate — 20% for basic-rate taxpayers, 40% for higher-rate, and 45% for additional-rate. The insurance company deducts tax at source through PAYE. For more on pension options and retirement planning, see our dedicated guide.

There are several types of annuity, each designed for different retirement needs. According to MoneyHelper annuity guide, understanding the options is crucial because once you buy, you're locked in for life.

Level annuity: Pays the same income every year for life. This gives the highest starting income but means your purchasing power falls over time as inflation erodes the value. A level annuity might suit someone who has other inflation-linked income (such as the State Pension) or who prioritises maximum income now.

Escalating annuity: Income increases by a fixed percentage each year (typically 3% or 5%). The starting income is significantly lower than a level annuity — often 25-40% less — but over a long retirement, the income eventually overtakes the level amount and continues growing. Suitable for younger retirees who expect a long retirement.

Inflation-linked (RPI/CPI) annuity: Income adjusts annually in line with the Retail Prices Index (RPI) or Consumer Prices Index (CPI). This provides genuine protection against rising prices but starts even lower than a fixed escalating annuity. In a high-inflation environment, this type can prove highly valuable.

Joint life annuity: Continues paying income (usually at a reduced rate, such as 50% or 66%) to your spouse or partner after you die. This costs more than a single life annuity because the insurance company expects to pay for two lifetimes, but it provides essential financial security for couples.

Enhanced (impaired life) annuity: If you have health conditions — such as diabetes, heart disease, cancer history, or even a BMI over 30 or a smoking habit — you may qualify for a higher income. This reflects the insurance company's assessment that they may not need to pay for as long. Always disclose your full health history, as the uplift can be substantial (10-40% more income).

Guaranteed period annuity: Includes a guarantee that payments continue for a minimum period (typically 5 or 10 years) even if you die. If you pass away within the guarantee period, payments continue to your estate or nominated beneficiary. This provides a safety net against 'dying early and losing everything' but reduces the headline rate slightly.

Fixed-term annuity: Pays income for a set number of years rather than for life, returning a maturity amount at the end. This hybrid product offers some annuity certainty while preserving flexibility to reassess at the end of the term.

Annuity rates are primarily driven by gilt yields — the return on UK government bonds. According to Bank of England base rate, when gilt yields rise, insurance companies can invest your purchase price at higher returns, allowing them to offer more generous income. When yields fall, rates decline.

The gilt yield surge that began in late 2022 — when yields spiked above 4% following the September 2022 mini-Budget — fundamentally reset the annuity market. After years of historically low rates (some below 3% for a 65-year-old), annuity rates climbed to levels that made them genuinely competitive with drawdown for the first time in over a decade.

As of early 2026, 15-year gilt yields remain elevated compared to the 2010s, supporting annuity rates that are still attractive by recent historical standards. A healthy 65-year-old man can typically expect a level annuity rate of around 6.5-7.5% on a £100,000 pot (meaning £6,500-£7,500 per year), depending on the provider and specific terms. Women receive slightly lower rates at the same age because of longer average life expectancy.

It's important to note that annuity rates vary significantly between providers. The difference between the best and worst rate for identical circumstances can be 15-20%, which is why shopping around using the Open Market Option is essential. Comparison services and financial advisers can search the whole market to find the best rate for your specific circumstances.

The Bank of England's base rate decisions also indirectly affect annuity rates through their impact on gilt yields. As the BoE has been gradually reducing the base rate from its 2023 peak, gilt yields have eased somewhat — but long-term yields are influenced by many factors beyond short-term monetary policy, including inflation expectations and government borrowing levels. For more on how interest rates affect annuity pricing, see our dedicated guide.

Since the 2015 pension freedoms, retirees have a genuine choice between annuities and flexible drawdown. Neither is universally better — the right answer depends on your circumstances, risk tolerance, and income needs.

Annuity advantages:

• Secure income for life — no investment risk, no market crashes to worry about
• Simple and predictable — you know exactly what you'll receive each month
• No ongoing management needed — set it up and forget about it
• Longevity protection — if you live to 100, the income keeps coming
• Enhanced rates for health conditions can offer exceptional value

Annuity disadvantages:

• Irreversible — once purchased, you cannot access the capital
• No inheritance value (unless you add a guarantee period or value protection)
• Level annuities lose real value to inflation over time
• If you die shortly after purchase, the insurance company keeps most of the capital
• Once locked in, you can't benefit from future rate improvements

Drawdown advantages:

• Flexibility to vary income up and down as needs change
• Capital remains invested and can grow
• Full control over your money — withdraw lump sums when needed
• On death, remaining funds pass to beneficiaries (potentially tax-free if under 75)
• Can buy an annuity later at a potentially better rate (older age = higher rate)

Drawdown disadvantages:

• Investment risk — poor market returns can deplete your pot
• Longevity risk — you could outlive your savings
• Requires ongoing management and decision-making
• Charges for investment management eat into returns

Many financial advisers now recommend a blended approach: use an annuity to cover essential fixed costs (housing, utilities, food, council tax) and keep the remainder in drawdown for discretionary spending and flexibility. The State Pension provides a foundation (£12,548 per year in 2026/27 for the full new State Pension), and an annuity can top this up to cover your baseline needs. For more on tax implications of pension income, see our dedicated guide.

One of the most important rules when buying an annuity is to never simply accept the rate offered by your existing pension provider. According to FCA retirement planning guidance, the Open Market Option (OMO) gives you the legal right to shop around and buy an annuity from any insurance company, not just the one that holds your pension.

The difference between providers can be substantial. For a £100,000 pension pot, the gap between the best and worst annuity rate might mean £500-£1,000 more income per year — compounded over a 20-30 year retirement, that's tens of thousands of pounds.

Steps to buying an annuity:

1. Take your tax-free lump sum first (if desired): You can usually take 25% of your pot tax-free before using the remainder to purchase an annuity.

2. Get quotes from multiple providers: Use comparison services or a financial adviser who can search the whole of the market. Key providers in the UK include Legal & General, Aviva, Canada Life, Just Group, and Scottish Widows.

3. Disclose your full health and lifestyle details: If you smoke, are overweight, take regular medication, or have any medical conditions, you may qualify for an enhanced annuity. Be thorough — even conditions like high blood pressure or high cholesterol can boost your rate.

4. Choose your annuity features: Decide on level vs escalating, single vs joint life, guarantee period length, and any other options. Each feature has a cost in terms of reduced starting income.

5. Consider financial advice: An annuity is irreversible and typically involves your life savings. The cost of professional advice (often £1,000-£2,500 for a pension annuity recommendation) is modest compared to the potential cost of making the wrong choice.

The FCA requires pension providers to inform you of the Open Market Option when you approach retirement. If your provider doesn't mention it, ask. And remember: you can buy multiple annuities at different times. There's no rule that says you must annuitise your entire pot at once — buying in stages (known as 'phased retirement') lets you lock in rates at different ages and potentially different gilt yield environments.

This article is for informational purposes only and does not constitute regulated financial advice. Pension rules and tax relief are subject to change. For personalised advice on your pension arrangements, consult a qualified financial adviser.. For more on saving and investing for retirement, see our dedicated guide. For more on investment platforms for drawdown, see our dedicated guide.