Most of us sleep better if we know we have a reliable source of income, especially in times of political upheaval. This is particularly true in retirement, when we are less able to work overtime or change jobs to generate extra income.
The state pension provides a bedrock of guaranteed income that rises each year, but modern workplace pensions make no such promise. For years, annuities, which provide a stream of income for life in exchange for a lump sum, have been out of favour.
But wealthy pensioners are once again flocking to these contracts amid growing fears that a financial shock is looming. For a year, markets have been nervous about a potential tech bubble linked to artificial intelligence. Now they have been thrown into uncertainty over conflict in the Middle East.
Experts say middle-class pensioners are seeking the comfort of annuities. The average annuity purchased in 2025 surpassed the £80,000 mark for the first time, hitting a new high of £84,000, according to industry data from the Association Of British Insurers.
And pensioners aren’t just dipping a toe in – they are putting large chunks, if not their entire pension, into annuities.
Experts say middle-class pensioners are seeking the comfort of annuities. And they’re not just dipping a toe in – they are putting large chunks, if not their entire pension, into them
Sales of annuities worth more than £250,000 soared by 31 per cent, while the biggest growth was in those bought with pots worth £500,000 or more, which rose by 54 per cent.
Experts say the surge is being driven by a mix of rising interest rates and a new hefty inheritance tax bill on pensions.
Here’s why annuities are the secret new tool to protecting your family from a large tax charge.
Exactly how do annuities work?
They pay an income that’s guaranteed for life in exchange for some, or all, of your pension. Just how much you get over time will depend on your health and how long you live, as well as interest rates at the time of purchase.
The higher the rate, the better the return insurance companies will get on the bonds they invest in, and the more they can pay out in income. You may also be able to get a better rate if you have any health problems, smoke or take certain medications, as underwriters assume you’ll have a reduced life expectancy.
If you’ve got a partner, you can take out a ‘joint life’ policy so that payments continue to be made to your spouse after you die.
But as they’re a type of insurance policy, you won’t get any remaining funds back when you or your partner dies (unless you pay extra for value protection or guarantee payments for a certain number of years).
How much value for money you get depends on whether you can outlive your insurance company’s expectations, as well as annuity rates at the time of purchase.
Why have they been out of favour?
Annuities have been almost entirely discounted as an option by most pensioners over the past decade. Prior to 2015, annuities were the default choice for most retirees. Most had to use their retirement savings to buy an annuity.
But that all changed with the introduction of so-called ‘pension freedoms’ rules in 2015, when Chancellor George Osborne announced that savers could manage their own pots of money.
Sales of annuities fell off a cliff as savers were given the option of drawing down from their pension pot, taking as much as they like, when they like.
With interest rates at just 0.5 per cent at the time, annuity rates were also at rock-bottom levels and savers overwhelmingly chose to leave their money invested in the stock market, where they could make larger returns, and use drawdown plans to manage their income themselves.
In April 2015, when the new rules were introduced, a 65-year-old with £100,000 in their pension could have secured an income of just £4,640 a year if they had used their entire pot to buy a joint-life annuity, according to research from retirement information website The Annuity Project.
Stephen Roberts, chartered financial planner at Shackleton Advisers, says: ‘For a period of more than a decade, annuities became incredibly difficult to recommend because drawdown appeared so much more attractive. People suddenly had full control over their pension pot, and the perception – rightly or wrongly – was that buying an annuity meant losing their capital when they died. Even those for whom an annuity was objectively the right answer were reluctant.’
So what is behind the resurgence?
Eleven years on from the introduction of the pension freedoms, the retirement income picture is looking somewhat different.
Market volatility, triggered by the war in the Middle East, has highlighted the risk of investing in stock markets during retirement. And, as Chris Ball, chief executive of Hoxton Wealth, points out, this won’t be a worry if you’ve got an annuity. He says: ‘Once you put your money into an annuity, market volatility is the insurance company’s problem.’
At the same time, interest rates – at a current level of 3.75 per cent – remain significantly higher than they have been for much of the past decade, which means payouts on annuities are far higher than they have been. Today, a £100,000 pension pot would buy you an income of £6,860 a year on a joint-life annuity. That is £3,018 a year more than you could get in July 2020. Over a 20-year retirement, that adds up to an extra £60,360.
William Burrows, who runs The Annuity Project and is a financial adviser at Eadon and Co, says: ‘People think taking drawdown is better than annuities, but with annuity rates at their current level, if you want to take income from your pension, annuities are quite a hard act to beat’
At the current rate, it would take 14 and a half years to make your money back. That means someone who takes out an annuity aged 65 would recoup their £100,000 shortly before their 80th birthday.
In contrast, someone who had taken out an annuity in July 2020 would have to wait an extra 11 and a half years to receive the £100,000 in annual income – 26 years. A 65-year-old who took out this annuity would have only broken even at the age of 91.
If the crisis in the Middle East continues, and interest rates go up, payouts could rise further.
Roberts adds: ‘Higher annuity rates mean people need to generate far higher investment returns in the market to match that guaranteed income. And with volatile markets and widespread economic uncertainty, that trade-off is far less clear than it used to be. Even for wealthy retirees, you need both a strong risk appetite and a large pension to justify fully relying on drawdown now. The balance has certainly shifted.’
William Burrows, who runs The Annuity Project and is a financial adviser at Eadon and Co, agrees that annuities can provide crucial reassurance in an uncertain world.
He says: ‘People think taking drawdown is better than annuities, but with annuity rates at their current level, if you want to take income from your pension, annuities are quite a hard act to beat.’
Some different ways to use annuities
There are several ways you can use annuities as part of your overall retirement income strategy – you don’t have to exchange your whole pension for guaranteed income. Adam Vanstone, of Chester Financial Planning, says: ‘For our wealthier clients, one approach we take is to use part of the pension pot to purchase an annuity to cover core living costs, rather than using the pension in full. This can create a secure income floor, along with the state pension, while preserving flexibility and growth potential with the remaining pot that stays invested.’
You can buy an annuity at any time in retirement and the income will be higher the older you are. This is because the insurance firm assumes you have fewer remaining years of life and are more likely to have health problems.
Adam Vanstone, of Chester Financial Planning, says: ‘For our wealthier clients, one approach we take is to use part of the pension pot to purchase an annuity to cover core living costs, rather than using the pension in full’
If you’ve got a decent-sized pension and your only source of inflation-proofed income is the state pension, you might also want to consider using an annuity where payments increase each year.
These inflation-linked or index-linked annuities rise by a set amount or in line with inflation each year. Vanstone says these can be a useful way to protect yourself against high inflation. He adds: ‘They are a more expensive option up front and pay a lower initial income, but the bigger the pension pot – and if you have availability of other assets to make up any income shortfall in the early years – the more attractive and appropriate this option could become.’
Ball adds: ‘2022 and 2023 [when inflation was in double-digits] are very ripe in people’s minds, and with Iran, oil prices and rising energy bills on the horizon, people are worried about a second pinch.’
If you don’t want to commit to a lifelong annuity, another option is a fixed-term annuity. These pay a fixed income for a period of three to 25 years and you can agree to have a guaranteed maturity value that is paid back to you at the end. Vanstone says: ‘A fixed-term annuity can also be used as a short-term “bridge”. For example, between early retirement and state pension age, when the pressure on finances is at its greatest.’
Burrows points out that you can use a fixed-term annuity as a cash investment – if you don’t take any income. Based on current rates, a £100,000 investment could get you £126,369 back in five years, a return of 4.65 per cent. The money is paid straight back into your pension and all gains are tax-free.
Use them as a sensible tax-planning tool
Rising annuity purchases aren’t just being fuelled by economic uncertainty and higher interest rates. Wealthy retirees are also using annuities to fend off the upcoming inheritance tax grab, with pensions becoming part of an estate, which means they could be subject to the 40 per cent death charge from April next year.
Ball says: ‘For years financial advisers have told clients that their pension is a really good tool for inheritance tax purposes. And now all of a sudden they are reading that isn’t the case. Some are looking at annuities as their base then gifting money they wouldn’t have before, like Isas and stocks and shares. Others are looking to gift it under surplus income rules.’
Ball says an annuity can be a helpful way of creating predictable, surplus cash to give away. So long as your gifts are regular, out of your income and do not impact your standard of living, you can give away as much as you like. Gifts will be out of your estate immediately – you won’t need to live a further seven years before they become tax-free.
Or you can spend the extra cash to boost your lifestyle – the important point is that the money isn’t sitting in your bank account when you die. But as Roberts points out, there are trade-offs. ‘Annuity income is taxable, which may mean paying more income tax than if the money remained inside the pension account,’ he explains.
And finally… the downsides
Whether you plan to use an annuity for retirement income or to avoid a tax bill, there’s a lot to consider. The biggest worry for most is that their estate is unlikely to get any money back when they die (or when their spouse dies with a joint-life annuity).
This might not be a concern if you lived well into old age and received more than you paid in. But dying soon after signing an annuity contract could be frustrating if the policy was taken out to avoid inheritance tax, James Scott Hopkins, founder of EXE Capital Management, points out. ‘Even with IHT taking a slice, beneficiaries will still receive something when a parent dies, whereas with an annuity it ends when the annuitant dies or, for a joint life annuity, on the second death.’
He adds: ‘In my experience, wealthier clients who do not need to draw more than 4 per cent from their pension each year are better off keeping their money in a pension and using drawdown. Although there are no guarantees, we have seen sensibly invested funds, especially in the investment trust equity income sector, maintain or increase dividends during various types of adversity.’
But Burrows says it’s important to think about the big picture and take into account the emotional aspect of retirement planning.
‘The decision on how to convert a pension pot into income is still one of the most complicated decisions in financial planning,’ he says.
Retirees need to consider several areas of risk: investment, longevity (the risk of living too long and running out of money), health and inflation.
Burrows says: ‘People tend to underestimate their life expectancy and underrate investment risk. But it’s at times like this that you realise that investment risk isn’t an abstract concept. It’s real. If there’s a stock market shock, you haven’t got time on your side.’
He adds: ‘There’s no one solution that hedges against all of those risks, so having a combination of solutions may well be the best thing to do.’
