The Income You Can’t Unbuy: What a 5% Annuity Really Promises

An annuity advert has a lovely trick. It shows you a number that never changes. Five per cent. Five thousand pounds a year for every £100,000 you hand over. After a decade of miserable rates, that looks less like a financial product and more like a small miracle with a direct debit attached.

But a level annuity is not really a yield. It is a promise measured in shrinking pounds. And in late 2026, with gilt yields still doing the heavy lifting behind annuity quotes, the gap between the advertised income and the income you can actually spend is the part nobody puts in the headline.

The brochure number is not the number that matters

Take the £100,000 pot. A 5% level annuity pays £5,000 a year, fixed in nominal terms. It does not care that your energy bill, your council tax or your Sunday pub lunch has other ideas. If inflation averages 3%, that £5,000 buys about £3,720 of today’s goods after ten years. After twenty years, it buys roughly £2,770.

That is not a rounding error. It is the whole argument.

A 5% annuity is often sold as a safe retirement income. Safe from what, exactly? It is safe from stock market falls. It is not safe from inflation, from changing care needs, or from the small matter of your own mortality arriving earlier than the insurer’s actuaries expect.

Where the 40% real-terms hit comes from

Let us keep the maths simple. You are 70. You buy a level annuity with £100,000 and get £5,000 a year. If you live another 15 years, you collect £75,000 in nominal payments. That already sounds less exciting than the brochure, because you have handed over six figures and received three-quarters of it back before inflation is even mentioned.

Now apply 3% inflation. Those fifteen £5,000 payments are worth about £60,000 in today’s money. Against the original £100,000, that is a real-terms loss of roughly 40%.

Retirement length	Nominal income collected	Real value at 3% inflation
10 years	£50,000	About £42,700
15 years	£75,000	About £59,700
20 years	£100,000	About £74,400

This is not a scare story. It is arithmetic. You can argue with the inflation assumption — 3% may be too high, too low or just about right depending on the next decade — but you cannot argue with the direction. A level annuity is a bet that inflation will behave. The insurer is not making that bet. You are.

Irreversibility is the fee nobody quotes

An annuity is not a savings account with a nicer font. Once you buy, you generally cannot unwind it. There is no cooling-off period measured in years. You have swapped a pile of capital for an income stream, and the capital is gone.

That matters because retirement is not a single decision. It is a series of decisions made with imperfect information. You might need care. You might want to help a child onto the housing ladder. You might discover that your spending in your seventies is lower than you thought — or that inflation in your personal basket is much higher than the official figure.

There is also the provider spread. Annuity rates are built from gilt yields, but not directly. The insurer takes the yield, subtracts its costs, its margin and its assumption about your lifespan, and offers you a rate. You see one number. The insurer sees a business. That spread is not a scandal; it is how the product works. But it means the headline 5% is already a discounted version of the market yield you read about in the paper.

Drawdown is not the hero of this story

It would be easy to turn this into an annuity-bashing piece and wave the drawdown flag. That would be just as lazy. Drawdown keeps your money invested, gives you flexibility and can be inherited. It also hands you sequence risk, fund charges and the very human temptation to withdraw too much after a bad year.

A 5% withdrawal from a drawdown pot is not the same as a 5% annuity. The annuity pools longevity risk across thousands of people. Drawdown does not. If you live to 95, the annuity keeps paying. The drawdown pot may not.

So the real comparison is not “annuity bad, drawdown good.” It is certainty versus flexibility. And certainty has a price. In a world where inflation can quietly eat a level payment, that price is higher than the advert suggests.

The narrow group who genuinely benefit

There are people for whom a level annuity makes sense. They are just not the crowd in the advert.

You are a plausible candidate if your essential spending — heating, food, council tax, insurance — is already covered by the state pension and any defined-benefit income, and you want a guaranteed top-up for the rest of your life. You are plausible if you have no dependants, no bequest motive and a family history of long life. You are plausible if you have a small pot where the cost and complexity of drawdown advice would swallow the benefit.

Enhanced annuities deserve a separate mention. If your health is impaired, an insurer may offer a higher rate because your life expectancy is shorter. For some people, that is a genuinely good deal — especially if they want certainty and do not need inflation protection. But it is a medically underwritten niche, not a general retirement strategy.

For everyone else, the question is not “should I buy an annuity?” It is “how much certainty can I afford, and at what price?”

The slice-it compromise

Most retirees do not need an all-or-nothing answer. They need a ladder. Buy certainty in slices. Keep some capital invested. Consider an inflation-linked annuity for the part of your income that must keep pace with prices, even though the starting rate is lower. Leave room for the unexpected.

A 5% level annuity is not a scam. It is a contract that sells certainty at a price. The price is inflation, flexibility and optionality. If you can genuinely afford to pay it, fine. But do not mistake the headline for the return. The income you cannot unbuy is rarely the income you actually wanted.

This is not financial advice. It is a warning label.