What decides the income an annuity pays for the rest of your life

A defined contribution pension, the kind most people now build up at work, is a pot of money. At some point that pot has to become an income. Since 2015 there have been several ways to do that: take cash, leave the money invested and draw on it, or buy an annuity. The annuity is the oldest of the three and the simplest to describe. You hand over a sum to an insurance company, and it pays you a regular income for as long as you live.

That certainty is what people buy. The cost is flexibility: the money is no longer yours to dip into, and if you die early the insurer may keep much of what is left unless you chose protection features at the start.

The tax-free part comes first

GOV.UK explains that you can usually take up to 25% of the amount built up in any pension as a tax-free lump sum, up to a maximum of £268,275 in total unless you hold a protected allowance. Many people take this cash first and use the rest to buy an annuity. The annuity income itself is then taxed like a salary or the State Pension: it is added to your other income for the year, and income tax is due on anything above your Personal Allowance, usually £12,570. The government has said the Personal Allowance will stay at that level until 5 April 2031.

What moves the income up or down

An insurer pricing an annuity is estimating how long it will have to pay you and what it can earn on the money meanwhile. Everything that changes those two estimates changes the income offered.

General tendencies only. Actual quotes depend on each insurer’s pricing on the day.

The choices that shape the income

Single or joint life. A single-life annuity stops when you die. A joint-life annuity continues to pay a partner, often at a reduced share such as half or two-thirds. The starting income is lower because the insurer expects to pay for longer, but for a couple who rely on the income it is often the central decision.

Level or rising. A level annuity pays the same amount every year. An escalating annuity rises, either by a fixed percentage or in line with inflation. It starts lower and takes years to overtake a level income, but it protects spending power in a long retirement.

Guarantee period and value protection. A guarantee period means the income continues to be paid, for example to your estate, for a minimum number of years even if you die early. Value protection returns some of the purchase price on death. Both reduce the starting income.

Enhanced annuities. Insurers will often pay more to people with health conditions or lifestyle factors, such as smoking, that shorten life expectancy. Answering the health questions fully can make a real difference.

Doing the sums

An illustrative case. Margaret has a pension pot of £120,000. She takes £30,000 (25%) tax-free and uses £90,000 to buy an annuity. Suppose a level, single-life quote paid £6,300 a year (an example figure, not a market rate). That income is taxable; with a full new State Pension of £241.30 a week (£12,547.60 a year in 2026/27) also coming in, almost all of her annuity would sit above the £12,570 Personal Allowance and be taxed at the basic rate of 20%. Her provider would deduct that tax through PAYE.

Why shopping around matters

You do not have to buy an annuity from the company that holds your pension. The Financial Conduct Authority found that many people were not switching provider when they bought an annuity, even though better quotes were often available elsewhere. Under rules the FCA introduced as a result, providers must show customers how their own quote compares with the highest quote available to them on the open market, and give details such as whether the annuity is single or joint life and whether the income is guaranteed.

An annuity is normally a once-in-a-lifetime purchase, so the time spent comparing quotes is time well used.

A decision that is usually permanent

Once the cancellation period has passed, an annuity cannot normally be cashed in or changed. That is why many people do not convert their whole pot at once. Some keep part of it invested in drawdown and buy an annuity later, when they are older and the income on offer is higher; others buy an annuity with just enough to cover essential bills alongside the State Pension. People with a final salary pension already have an income of this kind built in, which changes the calculation.

Who this matters for, and what to check

Annuities are worth understanding for anyone with a defined contribution pension who is within a few years of using it, and particularly for those who want a predictable income they cannot outlive. Before buying, it helps to:

• book the free Pension Wise appointment through MoneyHelper, available from age 50 to anyone with a defined contribution pension;
• check whether your pension has a guaranteed annuity rate, which may be worth far more than today’s market rates;
• gather full health and lifestyle information for enhanced quotes;
• decide whether a partner needs the income to continue;
• compare the open-market quote your provider must show you, and consider regulated financial advice for larger sums.

The short version

An annuity buys certainty: a guaranteed income for life, taxed like any other income after the usual tax-free cash. The starting figure depends on your age, health, whether it covers a partner, whether it rises over time, and wider interest rates when you buy. It is usually permanent, so compare quotes on the open market and use the free guidance available before deciding.