Annuity vs drawdown
In this guide: All the information you need to understand the difference between an annuity and drawdown and calculate your pension income.
An annuity and pension drawdown are the two main options for drawing an income from your pension pot.
The difference between drawdown and an annuity is that drawdown lets you withdraw money from your pension on a regular basis or as and when you need to, while an annuity provides you with a guaranteed income for life.
In simple terms, pension drawdown offers you more flexibility than an annuity but comes with some risk. An annuity gives you certainty with less risk than drawdown, but you will be more limited in what you can do.
Whether either option may be right for you will depend on your circumstances, retirement plans and attitude to investment risk. To help you weigh up whether an annuity or drawdown (or a combination of the two) may suit your pension income plans, here are the pros and cons of each.
An annuity is an insurance product that lets you use some or all of your pension to secure a regular income guaranteed for the rest of your life.
When you buy an annuity, you can choose options to protect your income against inflation, or to ensure that you can pass some of the benefits to your partner or beneficiaries if you die early – however these arrangements will reduce the amount of income you receive.
You can't change your mind once you've purchased an annuity, so it's important to shop around and compare annuities to ensure you make the right decision.
Our chosen partner Age Partnership, the retirement income specialists, can compare the whole of the market to find you the best annuity rates. There’s no obligation to go further and there’s nothing to pay, as the cost will be recouped from the annuity provider if you decide to go ahead.
The pros of buying an annuity
- Financial security – an annuity pays you a guaranteed, regular income for the rest of your life.
- Protection against inflation – you can arrange for the income to increase by a fixed amount each year or link it to an inflation-related measure like the Consumer Price Index (CPI) to protect your annuity against the effects of inflation.
- Protect your partner’s future – you can choose to buy a joint annuity so your partner can carry on receiving a proportion of the income after your death.
- Protect your capital – you can choose to protect the value of your annuity and ensure your partner will receive any remaining balance, if you die early.
The cons of buying an annuity
- No changes can be made– once you have purchased an annuity, you can’t adjust your income or change provider.
- No investment value – an annuity has no investment value as you no longer have a pension fund to benefit from investment growth.
- Cannot be passed on as an inheritance – you can't leave the value of your annuity to your family or other beneficiaries unless you buy protection at the start.
Visit Pension Wise for impartial information on your pension income options.
Pension drawdown, also known as flexi-access drawdown, is a flexible way to withdraw sums of money from your pension as and when you want to.
You can withdraw up to 25% as a lump sum tax-free. The rest of your pension pot remains invested, giving it the potential for investment growth. You can then decide if you want to take a regular income, or ad hoc amounts as and when you need them. The value of your investment can go down as well as up, so an income cannot be guaranteed.
Pros and cons of pension drawdown
The pros of pension drawdown
- Potential for your pot to grow – depending on the performance of your investments, your pension pot could continue to grow.
- Flexible withdrawals – you can vary your withdrawals to suit your circumstances and can increase or reduce how much you withdraw according to how your pension fund is performing.
- Can be left as an inheritance – you are free to bequeath your pension fund in your Will.
- Not considered part of your estate – pension funds are generally not subject to inheritance tax provided you nominate who should receive it on your death.
The cons of pension drawdown
- Investment risk – the value of the investments in your pension fund can go down as well as up. If the value falls, so will the money in your pot.
- An income is not guaranteed – unlike an annuity where a pension income is guaranteed for the rest of your life, the onus is on you to ensure your investments are performing and your pension fund lasts as long as you need it.
- You could run out of money – if you withdraw too much too soon, your money could run out.
To help decide whether an annuity or drawdown may be better for you, ask yourself three key questions: How often and for how long do you want to receive an income? Do you want to pass on your pension as an inheritance? How much risk are you willing to take?
How often and for how long do you want to receive an income?
If you would prefer a guaranteed income, a lifetime annuity will pay you a fixed amount on a regular basis for the rest of your life, so you can plan ahead with confidence and know you will not run out of money.
Once your annuity is set up, that’s it. You can’t switch to another provider or change to pension drawdown if you change your mind as you no longer have a pension fund.
If you would prefer the flexibility of drawing money from your pension fund when you wish, pension drawdown enables you to do this. You can change the value of your withdrawals to suit your current situation, and you can even buy an annuity later on if you decide you want more security.
However, you will need to keep a close eye on your investments and spending to ensure your pension pot lasts as long as you need it to.
Do you want to pass on your pension as an inheritance?
An annuity has no investment value to pass to loved ones on your death, but you do have options. For example, you could choose:
- A joint life annuity: a smaller payment will continue to be paid to your spouse or partner when you die.
- To guarantee payments for a number of years: an income will continue to pay out even if you died within that time.
- A value protection annuity: which enables you to leave your loved ones the value of the pension pot used to buy the annuity, less any income already paid.
Bear in mind that buying any extra protection will reduce the income you will receive.
With pension drawdown, any money left in your pension pot will be available for your beneficiaries on your death. The tax position of passing your pension fund on is determined by your age when you die:
- Up to age 75, your pension can usually be paid to your beneficiaries tax-free.
- Over the age of 75, any money they withdraw from your pension will be taxed at their marginal rate of income tax.
The value of your pension is unlikely to form a part of your estate for Inheritance Tax purposes, but you should complete a nomination form to ensure your executors understand your wishes.
How much risk are you willing to take?
An annuity holds much lower levels of risk than pension drawdown. It includes statutory protection of up to 90% of its total value. However, future inflation is a risk as your income is fixed and payable for life, so it could reduce in value over time.
With pension drawdown, your pension fund remains invested and investing, by its nature, involves a level of risk. While more risk means more potential for higher returns than an annuity, there are no guarantees. The value of your investment could fall and it will be your responsibility to ensure you don’t run out of money too soon.
Can I have an annuity and drawdown?
Yes, you can have an annuity and drawdown and, depending on your personal circumstances, it may make sense to do so.
For example, you could start by using pension drawdown and then use your remaining pension pot to buy an annuity when you’re older and entitled to better rates on a lifetime annuity, or eligible for an enhanced annuity due to poor health.
Get expert advice on annuities and pension drawdown
Speak to a retirement specialist at Age Partnership’s Pension Income Service now to learn more about pension annuities and income drawdown. They will explain all your options in plain English and give you the level of guidance or independent pensions and annuity advice you want.
They will also compare leading providers including Aviva, Standard Life, LV, Prudential, Canada Life, Hodge Lifetime and others to find the best pension income deal for you. So confident are they, they will give you a £100 if you manage to find a better like-for-like quote.