Buying an annuity: Turning pension savings into guaranteed income

As you approach retirement, one of the most important financial decisions you'll make is how to convert your pension savings into a reliable, sustainable income. With pension freedoms giving retirees greater flexibility, many have embraced drawdown strategies or taken lump sums. Yet annuities though sometimes overlooked, continue to offer unique and valuable advantages, particularly for those who prioritise financial certainty and simplicity.

When used strategically, buying an annuity can form the foundation of a stable retirement income plan, freeing you from the need to manage investments or worry about market volatility in later life.

What is an annuity?

An annuity is a financial product that converts your pension pot into a guaranteed income, either for life or for a specified number of years. Once you purchase an annuity from a provider, they pay you a regular income, which can be structured in various ways such as fixed, escalating with inflation, or including spousal benefits.

You typically buy an annuity with funds from a defined contribution pension. A portion of your pension pot (up to 25%) can be taken as a tax-free lump sum, with the remainder used to buy the annuity. The income you receive is then taxable, just like any other pension income.

When might an annuity make sense?

Annuities aren’t for everyone, but they can be an ideal choice in several circumstances:

• You want guaranteed income: Annuities remove uncertainty, giving you a predictable, regular payment regardless of market performance or economic fluctuations.

• You value peace of mind: If you’re concerned about outliving your savings or managing investments later in life, an annuity can provide long-term security.

• You have essential fixed costs: An annuity can be used to cover non-negotiable expenses such as housing, utility bills, food. Providing reassurance that your basic needs are always met.

• You have other flexible income: Many retirees use annuities to cover core living costs and supplement their income from drawdown pensions, ISAs, or other investments for discretionary spending.

Types of annuities to consider

There are several types of annuities available, each with features to suit different retirement needs:

1. Lifetime annuity

This is the most common type of annuity. It pays a guaranteed income for the rest of your life. You can choose:

• A level annuity, where the income stays the same over time, or

• An escalating annuity, where payments rise each year, either at a fixed percentage or in line with inflation (RPI/CPI).

While escalating annuities provide protection against inflation, they start at a lower initial income than level annuities.

2. Enhanced annuity

If you have certain health conditions, a lower life expectancy, or lifestyle factors such as smoking or a high BMI, you may qualify for an enhanced annuity. These offer a higher income than standard lifetime annuities, based on the assumption that your life expectancy is reduced.

Even minor health conditions can boost your income, so it’s worth providing full medical details when applying.

3. Joint life annuity

This type of annuity pays an income for as long as either you or your partner is alive. When you die, a percentage (typically 50% or 66%) of the income continues to your spouse or civil partner. This option can be valuable for couples who rely on one person’s pension and want to maintain financial stability for the survivor.

4. Fixed-term annuity

Rather than committing to a lifetime product, a fixed-term annuity provides income for a set number of years (for example 5 or 10 years). At the end of the term, you receive a “maturity amount” which you can use to buy another product or drawdown. This option offers more flexibility and may suit those not ready to lock in for life.

5. Value protection and guaranteed periods

Many people worry about dying shortly after buying an annuity and losing the value of their pension pot. To address this, annuities can include:

• Value protection: Refunds the unused portion of the original pension to your estate.

• Guaranteed periods: Ensures income continues for a set number of years (e.g. 5 or 10 years), even if you die during that time.

These features reduce the risk of “losing” your pension if you die early, though they may reduce your starting income slightly.

Is an annuity right for you?

Choosing whether to buy an annuity is a deeply personal decision and should be considered as part of your broader retirement strategy. Factors to weigh include:

• Your health and life expectancy

• The size of your pension pot

• Your need for flexibility versus certainty

• Other income sources (e.g. State Pension, drawdown, rental income)

• Your goals for passing on wealth

While annuities provide financial stability, they’re generally irreversible. Once you commit, you can’t change your mind so it’s essential to compare providers, understand all options, and ensure the product is tailored to your needs.

It’s also worth noting that annuity rates have improved in recent years, largely due to rising interest rates. This has made them more attractive again, especially for those seeking a guaranteed income without taking on investment risk.

Let’s weigh the options together

Annuities may no longer be the default retirement solution they once were, but in the right circumstances, they offer simplicity, certainty, and security. They can remove the burden of financial management and ensure your essential expenses are always covered, no matter how long you live.

Curious whether an annuity fits into your financial future?
Let’s explore your options together. We’ll help you weigh the pros and cons, consider your wider financial goals, and determine whether an annuity should play a part in your retirement plan.

Book for a complementary consultation today and let’s build a retirement income strategy you can count on.