What an annuity buys you
An annuity converts a pot into a guaranteed income for life. The trade is certainty for flexibility — and a level annuity that never rises loses buying power every single year.
What this calculator does
- Converts a pension pot into an annuity income at a quoted rate.
- Applies the tax-free lump sum first, so only the remainder buys the annuity.
- Models escalation, a guarantee period and a spouse's pension.
- Shows how long the income takes to return the purchase price.
How the calculation works
The pot is reduced by any tax-free lump sum, and the remainder is the purchase price. The annuity rate you have been quoted is applied to that amount to give the first year's income. The rate is not a market figure the calculator knows — it is specific to you, depending on your age, your health, where you live and the options you select, which is why shopping around and declaring health conditions routinely improves it. Escalation raises the income each year to offset inflation, but it starts from a much lower base, so a level annuity pays more initially and less later. A guarantee period continues payments to your estate if you die early, and a spouse's pension continues a share to a surviving partner; both cost money in the form of a lower starting rate. The years-to-recover figure divides the purchase price by the annual income, showing how long you need to live simply to get your own capital back before the insurer's risk-taking starts to work in your favour.
The rule
Purchase amount = pot − tax-free lump sum. First year income = purchase amount × annuity rate. Years to recover = purchase amount ÷ annual income.
Step by step
- Deduct the tax-free lump sum from the pot to give the purchase amount.
- Apply the quoted annuity rate to give the first year's income.
- Escalate the income each year if escalation was selected.
- Apply any guarantee period and spouse's proportion.
- Divide the purchase amount by the annual income to give the recovery period.
Worked example
Someone with a £300,000 pot takes the 25% tax-free lump sum and buys a level annuity at a quoted rate of 6%, projected over twenty-five years.
What was entered
| Pension pot | £300,000 |
|---|---|
| Take the 25% tax-free lump sum? | Yes |
| Annuity rate quoted | 6% |
| Annual escalation | 0% — level |
| Guarantee period | None |
| Spouse's pension | None |
| Projection period | 25 years |
The arithmetic
- A £75,000 tax-free lump sum leaves £225,000 to buy the annuity.
- At the quoted 6% rate that produces £13,500 a year, or £1,125 a month.
- The annuity is level, so the final year pays exactly the same £13,500 as the first — with far less buying power.
- Over twenty-five years the total income is £337,500.
- It takes about 17 years just to recover the £225,000 purchase price.
- With no guarantee period and no spouse's pension, payments stop entirely on death.
What the calculator returns
| Tax-free lump sum | £75,000.00 |
|---|---|
| Amount buying the annuity | £225,000.00 |
| First year income | £13,500.00 |
| Monthly income | £1,125.00 |
| Total income over 25 years | £337,500.00 |
| Years to recover the purchase price | 17 |
Key assumptions
- The annuity rate entered is one actually quoted to you, not a market average.
- Income is paid annually at the stated rate for the whole projection period.
- The projection period is a modelling choice, not a life expectancy.
Limitations
- Annuity income is taxable, and the figures here are before tax.
- A level annuity loses buying power every year. Over a twenty-five year retirement, inflation at even modest rates roughly halves what the same income buys.
- Buying an annuity is generally irreversible. Once purchased, the capital is gone and cannot be passed on except through the options selected at outset.
- Rates depend heavily on age, health and postcode. Enhanced rates for health conditions are common and are often missed by people who do not shop around.
- The years-to-recover figure is not a break-even test for whether an annuity is worthwhile — the point of an annuity is insuring against living a long time, not maximising expected return.
- This is a projection, not advice. Pension Wise offers a free appointment from age 50.
Common questions
Why would I accept 17 years just to get my money back?
Should I choose escalation?
Can I get a better rate?
What happens to the money when I die?
Related calculators
- Retirement Income Calculator — Compare with keeping the pot invested and drawing income flexibly.
- Retirement Target Calculator — Work out whether the pot will reach the size assumed here.
- Safe Withdrawal Rate Calculator — See what a drawdown withdrawal rate would need to be to match this income.
Official sources
Every figure in this guide was checked against the sources below. Where a source could not confirm a figure, it is marked as requiring verification rather than presented as settled.
- Tax on your private pension contributions: lump sum allowance — GOV.UKUsually up to 25% of a pension can be taken tax-free, capped by a lump sum allowance of £268,275
- Pension Wise: free pension guidance — MoneyHelperFree impartial guidance on pension options, available from age 50
- Guaranteed retirement income (annuities) explained — MoneyHelperHow annuities work, the options available and the effect of shopping around