Should I buy an annuity?
- Reeves Independent
- Oct 8
- 6 min read
As you near retirement, a key decision will be how to access your pension savings. A lot of people nowadays opt for Drawdown, which allows you to take money from your pension as and when you need it, giving you control over the amounts.
On the other hand, you can purchase an annuity. Annuities can provide the security of a guaranteed income for life, but they also come with trade-offs that may not suit everyone’s circumstances. Understanding how they work, the different types available, and how they compare with other retirement options is key to making an informed decision.
What is an annuity?
Traditionally, people would have purchased an annuity. However, in April 2015, pension freedoms were introduced, giving people much more flexibility over how they access their defined contribution pension savings from age 55 (rising to 57 in 2028).
Instead of being restricted to buying an annuity, you now have several options, which you can mix and match:
Take a tax-free lump sum - usually up to 25% of your pension can be taken tax-free.
Flexible drawdown – keep your pension invested and withdraw what you need, when you need it.
Buy an annuity – use some or all of your pension to secure a guaranteed income for life.
Take the whole pot as cash – though this may trigger a large tax bill, as anything above the 25% tax-free portion is taxed as income.
A combination – for example, taking a lump sum, drawing some income flexibly, and using the rest to buy an annuity.
The idea behind pension freedoms is to give you control, but with that comes responsibility: making the right choice for your circumstances and ensuring your money lasts throughout retirement.
An annuity works by exchanging some or all of your pension savings for a guaranteed income, usually paid monthly or annually, for the rest of your life.
Before setting up an annuity, you’ll usually have the option to take up to 25% of your pension as a tax-free lump sum. Alternatively, you can use that portion to increase your regular income payments. The income you receive from the annuity is treated as taxable income, but your provider will normally handle the tax automatically on your behalf.
The amount of income you’ll get from an annuity depends on several factors, including:
The total value of your pension
Your age
Your health and lifestyle
The annuity provider’s quote
Current interest rates
Whether you choose to provide an income for a partner or dependants after your death.
What are the pros and cons of an annuity?
Pros:
Financial security is a big pro of an annuity. Annuities provide a guaranteed income for life. This reliability can make it easier to plan ahead and enjoy extras, whether that’s home improvements, a well-deserved holiday, or simply the peace of mind of knowing exactly what will be paid each month.
Protection from market ups and downs is another major plus. With a standard annuity, your income is fixed and not impacted by stock market movements. This means you’re largely shielded from investment risks.
Boosted income potential is another highlight of an annuity. Depending on your health and lifestyle, it may be possible to qualify for an enhanced annuity, which pays a higher income. To make sure you get the best quote, it’s important to disclose any medical conditions or factors that might affect your life expectancy.
Cons:
Lack of flexibility is a reason they are unattractive to some. Once you purchase an annuity, the decision is usually permanent. You can’t cash it in or make significant changes, which means your income may not always adapt to your future needs.
Potential inflation risk is another downside. A fixed annuity income may not rise in line with inflation, which could reduce your spending power over time. You can opt to add inflation protection, but this usually means starting with a slightly lower income.
It’s a long-term commitment, which may not suit your needs. Buying an annuity is a lifelong decision, so it’s important to be sure it fits your long-term retirement plans.
How is an annuity paid?
Annuity income can usually be paid on a schedule that suits you - monthly, quarterly, half-yearly, or annually. The income is treated as taxable, and your provider will typically deduct tax using your tax code before paying you.
You may also have options for how payments are made:
In advance – at the start of each payment period
In arrears – at the end of each payment period
Some annuities offer proportionate payments. If you pass away partway through a payment period, a proportion of the next income payment may be made based on the days since the last payment.
If you’ve chosen a guarantee period or a continuing income for a dependant, you may also see references to:
With overlap – both any remaining guaranteed payments and the dependant’s income are paid simultaneously
Without overlap – the dependant’s payments start only after the guaranteed payments have finished
You may also be able to combine options, such as a joint income that rises with inflation. Keep in mind that the choices you make - timing, proportion, guarantee period, and dependants - can all affect the amount of income you receive.
Other factors that influence your annuity income include:
Where you plan to live in retirement
Your lifestyle, including weight and smoking habits
Your health at the time you set up the annuity
Where can I buy an annuity?
As you approach retirement, your pension provider will provide details about the value of your pension pot and the options available for accessing your savings.
Some providers may offer an annuity directly, but you are not obligated to take it from them. It’s important to shop around, just as you would for any significant purchase, to ensure you find the best option for your needs.
Remember, buying an annuity is usually a one-time decision - you generally can’t change your mind later. It’s therefore important to make sure it’s the right choice for your situation.
The income you receive, often called the annuity rate, and the setup charges can vary widely between providers. Choosing the wrong annuity could potentially cost you thousands of pounds over the course of your retirement.
You may also want to speak with a regulated financial adviser, who can help you choose the annuity that best suits your circumstances and retirement goals.
A tag-team of annuity and drawdown?
For some people, combining a pension annuity with income drawdown can provide the best balance between security and flexibility, but it depends on your individual circumstances, goals, and preferences.
A traditional annuity can give you the reassurance of a guaranteed baseline income that will continue for life. At the same time, keeping part of your pension invested through a drawdown arrangement allows you to access lump sums and control how and when you withdraw money.
It’s important to remember that tax rules may change and the tax treatment of your withdrawals will depend on your personal situation.
Fixed-term annuities: A Flexible, guaranteed bridge to retirement
A fixed-term annuity is a plan that gives you a guaranteed income for a chosen period of time. Sometimes called a fixed-term retirement plan, it could be a smart way to guarantee an income without committing your entire pension pot for life.
A fixed-term annuity allows you to use part of your pension savings to secure a guaranteed income for a set period - anywhere from 3 to 25 years - with the option to take a lump sum at the end.
Unlike a lifetime annuity, it doesn’t lock you in forever, giving you more control and flexibility over your retirement income strategy.
This approach can be particularly helpful if you want to bridge the income gap until your State Pension starts. For example, you could retire at 60, take a 7-year fixed-term annuity to cover essential expenses, then switch to drawdown or another income solution once your State Pension begins.
It could help you to preserve more of your pension fund for later - because you’re only using part of your pot, the rest stays invested, giving it more time to potentially grow.
Furthermore, it could enable you to enjoy certainty in uncertain markets, as your income payments are guaranteed for the chosen term, no matter how the markets perform.
When your fixed-term plan ends, you’ll have options - such as taking out another fixed-term annuity, buying a lifetime annuity, moving into drawdown, or simply taking the money as a lump sum. This flexibility means you can adapt your retirement strategy as your circumstances and goals evolve.
Fixed-term annuities offer stability when you need it most, without tying up your options for the long term.
Choosing how to access your pension is one of the most important decisions you’ll make for your retirement. Annuities can provide guaranteed income, protection from market fluctuations, and, in some cases, enhanced payments based on your health, but they also come with trade-offs such as limited flexibility and potential inflation risk. With so many options - including combining an annuity with drawdown - making the right choice can feel overwhelming.
At Reeves Independent, we help you navigate these decisions with clarity. By understanding your circumstances, goals, and preferences, we guide you toward the options that suit you best. Our aim is to empower you to retire with confidence, knowing your income is secure and your retirement lifestyle is exactly what you want.
