Should I buy an Annuity? Discover the eye-opening truth now

Key Takeaways

Rates Are at a Historic High: Annuity rates are the highest they have been in over 16 years, but there is a consensus that they may have peaked and could fall over the next year.
Guaranteed Income for Life: The core benefit of an annuity is that it eliminates investment risk and the risk of outliving your savings (longevity risk) by providing a secure, guaranteed income for the rest of your life.
Inflexibility is the Main Trade-Off: Once you buy an annuity, the decision is generally irreversible. With a standard annuity, the capital is gone upon death, meaning no inheritance for loved ones from that pot.
Annuity vs. Drawdown: The key decision is a trade-off between the certainty and security of an annuity versus the flexibility, investment control, and inheritance potential of flexible access drawdown.
Protecting Your Partner: A joint life annuity can provide a guaranteed, ongoing income for a surviving spouse or partner, offering a level of security that a drawdown plan exposed to market risk cannot.
Estate Planning Benefits: Purchasing an annuity removes a lump sum from your pension pot, which can be an effective way to reduce a potential Inheritance Tax (IHT) liability, a particularly relevant consideration given potential future changes to pension IHT rules.

Take Risk off the Table - Retirement with a Guaranteed Income

The primary appeal of a lifetime annuity is its ability to remove uncertainty from retirement planning. In exchange for a lump sum from your pension pot, an annuity provider guarantees to pay you a regular income for the rest of your life, no matter how long you live. This contractual guarantee provides a powerful shield against several key retirement risks:

Investment Risk: Unlike a drawdown portfolio, which remains exposed to the volatility of the stock market, an annuity provides a predictable income stream, irrespective of market crashes or economic downturns. This can provide immense peace of mind, especially for those who are risk-averse or have a lower capacity for loss.
Longevity Risk: With people living longer than ever, the fear of outliving one’s savings is a genuine concern. An annuity provides a safeguard against this by ensuring that your income will not run out, providing a financial foundation for your entire retirement.
Inflation Risk (with the right product): While a basic level annuity can see its purchasing power eroded by inflation over time, you can opt for an escalating annuity. This type of annuity sees the income increase each year, either by a fixed percentage or in line with an inflation measure like the Retail Prices Index (RPI), helping to protect your income from the rising cost of living.

The Benefits and Downsides of Annuities

Benefits:

Certainty: The guaranteed income for life is the cornerstone benefit, allowing for straightforward budgeting and financial planning.
Simplicity: Once set up, an annuity is a ‘hands-off’ product, requiring no ongoing investment decisions or monitoring.
Higher Rates for Ill Health: If you have a medical condition or a lifestyle factor (like smoking) that could reduce your life expectancy, you may qualify for an ‘enhanced’ or ‘impaired life’ annuity, which offers a higher income.
Spouse’s Protection: Joint life annuities can provide a continuing income for your spouse or partner after you die, ensuring they are not left financially vulnerable.

Downsides:

Inflexibility: Once you have purchased an annuity, the decision is generally irreversible. You cannot usually cash it in or alter the terms, even if your circumstances change.
No Capital to Pass On: With a standard single life annuity, the income payments cease upon your death, and the original capital is retained by the provider. This means that, unless you have chosen specific death benefits, there will be no remaining pension funds to leave to your loved ones.
Inflation Erosion (for level annuities): A level annuity will pay the same amount each year, meaning its real value will decrease over time due to inflation.
Potentially Lower Returns: In a strong investment market, a drawdown portfolio has the potential to generate higher returns than an annuity.

Current Annuity Rates: A Golden Opportunity?

As of early 2025, UK annuity rates are at their highest levels in sixteen years. This surge has been primarily driven by the rise in long-term interest rates and gilt yields. Gilt yields are the interest rate paid on UK government bonds, and annuity providers use these to generate the income they promise to pay out.

A healthy 65-year-old with a £100,000 pension pot could currently secure a level single life annuity of around £7,500 per year. This is a significant increase from just a few years ago.

Have Rates Peaked?

The consensus among many financial experts is that we may be at or near the peak for annuity rates. The Bank of England is widely expected to start cutting its base interest rate in the coming year to stimulate economic growth. A fall in the base rate would likely lead to a corresponding drop in gilt yields, which would, in turn, reduce the annuity rates offered by providers.

While a sharp crash in rates is not anticipated, those considering an annuity in the near future may wish to act sooner rather than later to lock in the current high rates.

What Determines the Annuity Rate You're Offered?

Several factors influence the income you will be offered:

Your Age: The older you are when you buy an annuity, the higher the rate you will receive, as the provider expects to pay out for a shorter period.
Your Health and Lifestyle: As mentioned, medical conditions and lifestyle choices can lead to a higher income through an enhanced annuity.
The Size of Your Pension Pot: A larger pension pot may command a slightly better rate.
Gilt Yields and Interest Rates: These are the most significant market factors influencing annuity rates.

The Type of Annuity and its Features:

- Single vs. Joint Life: A single life annuity will offer a higher income than a joint life annuity, as the latter is designed to continue paying out to a surviving partner.
- Guarantee Periods: You can add a guarantee period (e.g., 5 or 10 years) which ensures that if you die within that timeframe, the income will continue to be paid to your beneficiaries for the remainder of the period. This will slightly reduce the starting income.
- Level vs. Escalating: An escalating annuity will have a lower starting income than a level annuity to account for the future increases.

Annuity vs. Flexible Access Drawdown: The Inheritance Dilemma

Since the introduction of pension freedoms in 2015, flexible access drawdown has become a popular alternative to annuities. Drawdown allows you to keep your pension pot invested and draw an income from it as and when you need it.

The Case for Drawdown:

Flexibility: You can vary your income, take lump sums, and have complete control over your funds.
Potential for Growth: Your remaining pension pot can continue to grow through investment returns.
Inheritance: Any funds remaining in your drawdown pot upon your death can be passed on to your beneficiaries, often tax-efficiently. If you die before age 75, the funds can usually be inherited completely tax-free. If you die after 75, your beneficiaries will pay income tax on the withdrawals at their marginal rate.

The Risks of Drawdown for a Spouse:

While drawdown offers significant advantages in terms of inheritance, it also carries risks, particularly for a surviving spouse.

Market Risk: A significant market downturn could severely deplete the value of the drawdown pot, reducing the income available for both you and your surviving spouse.
Depletion of Funds: Taking an unsustainable level of income could lead to the pension pot running out prematurely, leaving your spouse with no financial support from that source.
Complexity and Stress: Managing a drawdown portfolio requires ongoing attention and can be a source of stress, especially for those who are not experienced investors.

A joint life annuity can mitigate these risks for a spouse by providing them with a guaranteed income for their lifetime after your death, offering a level of security that drawdown cannot match.

Do People See the "Full Value" of Their Annuity?

The question of whether people live long enough to get their original investment back from an annuity is a common one. Annuity rates are calculated based on average life expectancies. This means that, on average, some people will die earlier than expected, and the insurer will make a “profit,” while others will live longer than expected, and the insurer will make a “loss.” This pooling of risk is the fundamental principle of insurance.

It’s more helpful to view an annuity not as a traditional investment with a “break-even” point, but as a form of insurance against outliving your savings. You are paying for the certainty of a lifelong income, regardless of how long that may be.

While there are no definitive statistics on the proportion of people who “profit” from their annuity, the peace of mind that comes from a guaranteed income is, for many, the true value.

Annuities and Estate Planning: A Changing Landscape

Historically, pensions have been a very effective tool for estate planning as they typically sit outside of your estate for Inheritance Tax (IHT) purposes. However, the UK government has announced that from 2027, this is set to change, and pension funds may be brought within the scope of IHT.

This upcoming change makes annuities a potentially more attractive option for estate planning. By using a pension pot to purchase an annuity, you are converting a capital sum (which could be subject to IHT) into an income stream. This can effectively remove that capital from your estate.

For those with large pension pots who are concerned about IHT, a strategy of using a portion of their pension to buy an annuity to cover their essential expenditure, while leaving the rest in drawdown for flexibility and potential inheritance, could be a very effective approach.

Author:

Andrew Rankin BA (Hons), DipPFS

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Annuities are a powerful tool for taking risk off the table in retirement. The current high rates present a compelling opportunity for those seeking the security of a guaranteed income. However, the decision to purchase an annuity should not be taken lightly. It is crucial to weigh the benefits of certainty against the inflexibility and the desire to leave a legacy.

For many, a blended approach that combines the security of an annuity to cover essential outgoings with the flexibility of drawdown for discretionary spending and potential inheritance may offer the best of both worlds. As with all significant financial decisions, seeking independent financial advice is essential to ensure you make the right choice for your individual circumstances.

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The decision between an annuity and drawdown is one of the most important you’ll make for your financial future. To navigate the complexities and ensure the choice is right for your unique circumstances, seeking professional guidance is a crucial next step.

For a clear, personalised retirement plan, contact your local Worcester-based Independent Financial Adviser today to arrange an initial consultation.

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Sources:

Sharing Pensions – Annuity Rates Tables UK. (Accessed June 2025)
Which? – Have annuity rates reached their peak? (Accessed June 2025)
Legal & General – Annuity vs drawdown – what’s the difference? (Accessed June 2025)
Royal London – Pension death benefits. (Accessed June 2025)
RTS Financial Planning – Shielding Your Pension from Inheritance Tax. (Accessed June 2025)

Risk Warnings:

An annuity is a long-term financial product and is not suitable for everyone.
Once purchased, an annuity cannot usually be changed or cashed in, so it is a significant commitment.
The income from a level annuity will not increase in line with inflation, and its purchasing power will reduce over time.
The value of investments in a flexible access drawdown plan can go down as well as up, and you may get back less than you invested.
Tax rules can change, and their value to you will depend on your individual circumstances.
This article does not constitute financial advice. You should seek independent financial advice before making any decisions about your retirement income.