An annuity converts a lump sum into a stream of payments for life. What is bought is certainty; what is given up is control of the capital.
The insurer takes on longevity risk
An individual planning their own drawdown must guess how long the money needs to last, and no single person can know the answer.
An insurer covering many annuitants faces a predictable average lifespan across the group, even though any individual outcome remains uncertain.
Payments to those who die early fund payments to those who live long. This pooling is the core of what an annuity provides and cannot be replicated privately.
Pricing rests on interest rates and mortality
The insurer invests the premium, mostly in bonds matched to the expected payment schedule, and the yield available determines how much income the capital can support.
Higher prevailing interest rates therefore mean more income per unit of capital, which is why the same sum buys noticeably different amounts at different times.
Assumed life expectancy works in the opposite direction, and factors such as age and health at purchase adjust the quoted rate accordingly.
Access to capital ends at purchase
Once a conventional annuity begins, the capital belongs to the insurer. There is no balance to draw on for an unexpected expense.
Death benefits, guaranteed periods and joint-life options can preserve value for a partner or estate, but each reduces the income paid.
The exchange is explicit: every guarantee attached to the contract is funded by lowering the payment, since the insurer is retaining more risk.
Inflation is a separate decision
A level annuity pays the same nominal amount for life, which loses purchasing power steadily even at modest rates of inflation.
An escalating or index-linked annuity protects against that, at the cost of a substantially lower starting payment that takes many years to catch up.
Which is preferable depends on expected longevity and on what other income is already inflation-protected, which varies widely between individuals.
Partial annuitisation is the common middle ground
Covering essential expenses with guaranteed income while leaving discretionary spending to an invested portfolio addresses both risks without committing everything.
This preserves flexibility for large or unexpected costs while ensuring that a market decline cannot threaten the spending that cannot be reduced.
The split depends on what other guaranteed income exists and on the size of the fixed commitments, and the treatment of these products varies considerably by jurisdiction.