An annuity solves a problem no portfolio solves: it pays for as long as the holder lives, however long that turns out to be. The price of that certainty is the capital itself.
The risk being transferred is longevity
Someone drawing from savings faces the possibility of living longer than the money lasts, and that risk cannot be diversified by an individual.
An insurer pooling many annuitants faces a predictable average lifespan across the group, even though each individual outcome is unknown.
Payments to those who die early fund payments to those who live longest, which is the mechanism that allows income to be guaranteed for life.
How the payment rate is set
The insurer estimates how long payments will continue and what return it can earn on the capital in the meantime, then works backwards to an amount.
Prevailing interest rates therefore drive annuity rates directly, since the insurer is largely investing in bonds to match the promised payments.
Age matters for the same reason. A shorter expected payment period allows a higher rate, which is why rates offered rise with the age at purchase.
Health and features change the calculation
Conditions that reduce life expectancy can increase the rate offered, because the expected payment period shortens, which is the reverse of most insurance pricing.
Features that protect the holder reduce the rate. Payments that rise with inflation, continue to a spouse, or are guaranteed for a minimum period all cost something.
Each feature is priced separately, so comparing quotes requires comparing identical structures rather than headline figures.
What is given up in exchange
The capital is generally surrendered permanently. It cannot be accessed for an emergency, redirected, or left as an inheritance unless a feature providing for that was purchased.
The holder also gives up any upside from investment returns, since the payment is fixed by the terms rather than by how markets perform.
Fixed payments lose purchasing power over a long retirement unless indexation was included, and indexation substantially reduces the starting amount.
Why partial annuitisation is common
Using part of a pot to cover essential costs and leaving the remainder invested provides a floor without surrendering all flexibility.
The floor is what changes the character of the plan, since guaranteed income covering necessities removes the risk that a market fall affects basic spending.
Availability, tax treatment and the rules governing these products differ substantially by country and change over time, so individual advice is warranted before committing capital irreversibly.