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Annuity Guide

An annuity is a financial product that converts a lump sum of pension savings into a guaranteed income for life, or for a fixed period. While the pension freedoms of 2015 made drawdown the more popular choice, annuities remain an important retirement option, particularly for those who value certainty and want to ensure they have enough guaranteed income to cover essential living costs. An annuity removes investment risk and longevity risk — you cannot outlive your income — but it also sacrifices flexibility and typically offers no residual value on death unless specific features are selected.

Single Life vs Joint Life Annuities

A single life annuity pays an income for your lifetime only. When you die, the income stops (unless a guarantee period applies). A joint life annuity continues to pay an income to your spouse, civil partner, or another beneficiary after your death, typically at a reduced rate such as 50% or 67%. Joint life annuities are popular with couples who want to ensure the surviving partner retains a minimum income. The initial income from a joint life annuity is lower than a single life annuity because the insurer expects to pay income for longer. Choosing the right survivor percentage involves balancing the initial income level against the surviving partner's needs.

Level vs Escalating Annuities

Level annuities pay the same income amount every year for the rest of your life. The income is fixed in nominal terms, meaning its real value is eroded by inflation over time. An escalating annuity increases the income each year, either by a fixed percentage (commonly 3% or 5%) or in line with the Retail Prices Index (RPI). Escalating annuities start with a lower initial income than level annuities but the income grows over time, protecting purchasing power. For someone retiring in their 60s with a 20- or 30-year retirement ahead, the inflation protection of an escalating annuity can be valuable, but the lower starting income may be a constraint if you need income immediately.

Fixed-Term Annuities

A fixed-term annuity pays a guaranteed income for a set period (e.g. 5, 10, or 15 years) rather than for life. At the end of the term, you get a guaranteed maturity amount (a return of some or all of the original capital), which you can use to buy another annuity, enter drawdown, or take as cash. Fixed-term annuities offer more flexibility than lifetime annuities and are sometimes used as a bridge between retirement and the later years when a lifetime annuity might be more attractive. They can also be useful if you want to defer a lifetime annuity purchase until rates improve or until your health changes, potentially qualifying you for an enhanced annuity.

Investment-Linked Annuities

Investment-linked annuities (also called with-profits annuities or unit-linked annuities) offer income that varies depending on the performance of underlying investments. The initial income is typically lower than a level annuity, but there is potential for income growth if investments perform well. These products carry investment risk — the income can fall as well as rise — and are more complex than conventional annuities. They suit people who are comfortable with some investment risk but still want a guaranteed minimum income floor. Investment-linked annuities are much less common than conventional annuities and require careful due diligence on the provider and the underlying funds.

Enhanced Annuities

If you have health conditions or lifestyle factors that are likely to reduce your life expectancy, you may qualify for an enhanced annuity (also called an impaired life annuity or a medical annuity). These annuities pay a higher income than standard annuities because the insurance company expects to pay it for a shorter period. Health conditions that can qualify include diabetes, high blood pressure, heart disease, cancer, stroke, respiratory conditions, and being overweight. Lifestyle factors such as smoking can also qualify. It is estimated that over 40% of people approaching retirement could qualify for an enhanced annuity, yet many do not disclose their health information and miss out on higher rates. Always disclose relevant health and lifestyle information when getting annuity quotes.

Open Market Option

The open market option (OMO) is your right to shop around for the best annuity rate rather than accepting the one offered by your existing pension provider. Using the OMO can increase your income by 10% to 30% compared to staying with your current provider, as annuity rates vary significantly between insurers. You are not obliged to take the annuity offered by your pension company — you can take the entire fund to another provider who offers a better rate. Since 2017, the FCA requires providers to prompt customers to use the OMO at retirement. You should get quotes from at least three or four different annuity providers and consider using an independent financial adviser or a specialist annuity broker who can search the whole market for the best rate.

Drawdown vs Annuity: Which Is Right for You?

The choice between drawdown and an annuity depends on your personal circumstances, risk tolerance, and financial objectives. Drawdown offers flexibility, investment growth potential, and valuable death benefits, but you bear investment and longevity risk. Annuities offer guaranteed income for life, removing those risks, but you give up flexibility and usually have no residual value on death (unless you add a guarantee period or value protection). Many people use a combination: an annuity to cover essential costs (mortgage, bills, food), with the rest in drawdown for discretionary spending and future flexibility. This "hybrid" approach provides a secure income floor while retaining access to capital for unexpected expenses or lifestyle goals.