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When it comes to planning for your retirement, one of the most important decisions you’ll make is how you will draw money from your pension. Two widely-used options for accessing your personal pension in the UK are annuities and pension drawdown.
There are pros and cons to both annuities and drawdown, so it’s important you know all of the facts before making a decision about your pension. Below, we compare these two options in more depth to help you determine which option is most suitable for you.
What is Pension Annuity?
A pension annuity provides you with a regular income during your retirement, in exchange for a lump sum payment. The annuity is purchased with the pension savings acquired during your working life, or with a combination of your savings and additional payments from your employer or the government.
You’ll receive a guaranteed and secure income every month for the rest of your life, regardless of how long you live. These payments cannot be altered and large lump sums cannot be withdrawn.
A pension annuity is essentially a form of insurance, where you’re guaranteed a fixed amount of income for an agreed period of time (usually the remainder of your lifetime). With a standard annuity, when you die the remainder left in the pot stays with the provider, and no further payments are made to your family members. However, there is the option for a joint pension annuity, where your partner is partially protected.
Other types of annuities include fixed-term annuities, which provide a guaranteed income for a specific period of time, as well as lifetime annuities, which provide a guaranteed income for the rest of your life, however long that is.
Advantages of Pension Annuity
The main advantage of a pension annuity is that it provides you with a stable and predictable income throughout your retirement. You’ll have the confidence of knowing you’ll receive a fixed amount for the rest of your life. This can be particularly beneficial if you are concerned about market volatility, as annuities provide a level of financial security that protects you from wider global problems in financial markets.
Due to the fixed structure of the payments, you’ll be less likely to spend all of your money quickly. Because you won’t be able to withdraw funds from your pot, this eliminates the risk of making costly mistakes through bad investments or irresponsible spending.
Disadvantages of Pension Annuity
One of the biggest drawbacks of annuities is that they offer limited flexibility. Once you purchase an annuity, you cannot make any changes to the terms of the contract. This means that you cannot adjust the income payments to reflect changes in your financial needs.
Unless the fund is particularly large, with the monthly payments you receive it’s unlikely you’ll be able to afford large one-off investments, such as buying a property. You’ll need to weigh up this limited flexibility against the security of having guaranteed regular payments.
Also important to consider is that with single life annuities income payments will stop when the annuitant dies, meaning any remaining value won’t be passed on to your loved ones. If you opt for a joint annuity (survivors annuity), the payments will last for the rest of your life, plus the life of another named person (partner or family member). However, monthly income payments are typically smaller with joint annuities, accounting for the fact that they will probably be paid out for longer.
What is Pension Drawdown?
Pension drawdown, the most common alternative option to an annuity, allows you to withdraw regular monthly or larger one-off sums from your pension fund, while leaving the remainder in place. With drawdown you’re free to withdraw your funds as you wish, even the full amount. Because of this level of freedom, you have a greater responsibility for the performance of your funds.
Any money that you choose to keep in your pension savings is invested in the stock market or other assets. The amount of income you’ll be able to take from drawdown will depend on the performance of your investments, so it is not guaranteed and can fluctuate over time.
There are different types of drawdown, including capped drawdown, which limits the amount you can withdraw each year, and flexible drawdown, which allows you to withdraw as much as you want, subject to certain conditions.
To learn more, read our in depth guide: What is Pension Drawdown & How Does it Work?
Advantages of Pension Drawdown
The biggest advantage of pension drawdown is the flexibility and control that it offers. You can adjust the amount of income you receive accordingly, based on your changing financial needs or market conditions. You’ll have the freedom to withdraw or leave as much as you wish.
For instance, you might want to make large withdrawals to buy property, support your family or just to enjoy your well-earned money on a bit of luxury during your retirement. Anything you do leave in the pot remains invested, giving it the potential to grow.
Additionally, unlike pension annuities, any remaining funds in your drawdown account can be passed on to family members when you die.
Disadvantages of Pension Drawdown
Pension drawdown naturally carries greater risk than an annuity. If your investments perform poorly, your income may decrease and you could run the risk of depleting your savings over time. There is no guarantee that you will receive a steady income throughout your retirement, as it depends on the performance of your investments. Here’s where it helps to seek professional pension and investment advice from a specialist, who can help you make decisions about what to do with your money.
Another potential downside is that if it’s withdrawn quickly and spent irresponsibly, your money can quickly run out. Greater freedom and control over your fund also means greater responsibility, which is ideal for some but risky for others who aren’t as sensible when it comes to spending and saving.
Which is better: drawdown or annuity?
While some people want a fixed income in their retirement (annuity), others would prefer to draw out some of their pension while continuing to invest the rest in stocks and shares (drawdown). There isn’t a ‘better’ option, it’s about deciding which one is the most suitable choice for your circumstances.
When you’re choosing between a pension annuity and drawdown, three important things to consider are your personal financial situation, goals and risk tolerance.
If you are risk-averse, looking for a stable and predictable income in retirement, an annuity may be the more suitable option for you. An annuity provides you with a guaranteed income for life, eliminating the risk of outliving your savings. Additionally, it offers peace of mind and financial security.
If you are more comfortable with risk and prefer greater flexibility, you may prefer a pension drawdown. Drawdown allows you to adjust your income based on your changing financial needs and market conditions. Additionally, it offers the potential for higher returns, as your investments are not restricted to a fixed income stream.
To find out how much income you might be able to get with an annuity and compare this to drawdown, check out our guide: How Much Annuity Income Will I Get?
Further Support With Pension Annuities and Drawdown
As with making any big decision regarding your pension, it’s always recommended to seek professional advice. Almond Financial are professional financial advisors, experienced in providing expert pension advice on both annuities and drawdown.
FAQs
Can you combine drawdown and annuity plans?
Yes, you aren’t restricted to just one or the other. It’s possible to use part of your pension to buy an annuity and keep the remainder invested in a drawdown plan, where it has the potential to grow. This means you can benefit from the security of having a fixed income through an annuity plan, while also being able to dip into your drawdown pot for larger withdrawals when required.
Is an annuity the same as a pension?
The term ‘pension’ generally refers to the money saved over someones working life to provide an income during retirement. A pension can be accumulated through a workplace pension scheme, personal pension plans, or other retirement saving methods. Once you reach retirement, you have choices on how to access that pension pot.
An annuity however, is just one of the options available to you to convert your pension pot into a regular income. So, while a pension refers to the overall savings or pot accumulated, an annuity is a product you can buy using those savings to provide a guaranteed income.
What’s the difference between a fixed term annuity and drawdown?
Fixed term annuities provide a regular income for a certain amount of time, whereas with flexi-access drawdown you keep your funds invested and you’re able to withdraw any amount whenever you wish.
With a fixed term annuity you can benefit from some of the reliability and security that an annuity provides, while keeping your future financial planning options open. With drawdown, you retain full control and flexibility, but it comes with its own risks.
If you’re unsure whether to choose a fixed term annuity or pension drawdown, speak to a pension advisor who can help you make the right choice.
How are drawdown and annuities taxed?
With defined contribution pension schemes, you can take the first 25% of your overall pension value as a tax-free lump sum. After this, whether you choose drawdown or an annuity plan, any income you take is taxable above your personal allowance. The exact amount you pay on drawdown or an annuity will depend on your individual circumstances.
Pensions and Investment Risk Warning: The value of pensions and investments can fall as well as rise. You may get back less than you invested.
