Annuity vs drawdown - which is best for retirement?
Should I choose drawdown or buy an annuity?
You can access your pension from the age of 55 (57 from April 2028), but exactly how you take the income – via drawdown or annuity – is an important decision to make.
It is a decision that will affect your retirement for years, or even decades to come. Whether you want the freedom and flexibility to choose your annual income with drawdown, or you want the security and steady income of an annuity, there are pros and cons to each.
Some people choose a combination – buying an annuity with some of their pension, and keeping the rest in a drawdown agreement - for the best of both worlds.
What is drawdown?
Pension drawdown gives you the flexibility to take whatever income you wish from your pension pot. After withdrawing your 25% tax-free allowance (subject to maximum of £268,275), you will pay income tax on the remaining funds as and when you take an income payment. A benefit is that your pension stays invested, so it could continue to grow throughout your retirement.
Advantages of drawdown
- Flexibility: Since drawdown allows you to take whatever income you need, it is much more flexible than an annuity.
- Tax: Should you die before age 75, your beneficiaries will inherit your entire remaining pension pot and would be able to take a tax-free income from it. They could also take it as a tax-free lump sum subject to your remaining Lump Sum and Death Benefit Allowance (LSDBA). Read more about Lump Sum Allowances.
- Potential growth: The money you do not withdraw remains invested, so your pension has the potential to grow.
Downsides of drawdown
- Market risk: Although your pension remains invested for the possibility of further growth, it is also possible for the value to decrease in poor market conditions.
- Regular management: A drawdown needs to be managed carefully, otherwise you could run out of money in early retirement.
What is an annuity?
An annuity is a pension arrangement that you can buy with all or part of your pension pot. Essentially, you are buying a guaranteed income, either for the rest of your life or for a fixed period.
The main types of annuity are:
- A level annuity that keeps your income the same every year.
- An investment-linked annuity that gives you a guaranteed minimum income. If your investments grow, your income grows.
- An inflation-linked annuity that increases every year with inflation.
Your annuity rate - or annual income - depends on lifestyle factors, your age, and where you live.
How do annuities compare with drawdown?
Here are the main features of annuities versus a drawdown pension.
| Annuity | Drawdown | |
|---|---|---|
| Income | Guaranteed but annual income is limited | Unlimited but needs managing so you do not run out of money |
| Reliability | Can be taken for life | Can run out of money early, but investments could grow your overall pot |
| Ease of use | Simple one-time purchase | Needs regular management |
| Flexibility | You cannot get out of an annuity, but you do not have to buy one with your entire pension pot | Can transfer to another pension arrangement |
| Inheritability | Single-life plans cannot be passed on and cease on death. Joint-life plans can only be passed on and be benefited by your partner (usually 50% of the original annuity) | Your beneficiaries will inherit your entire remaining pension pot and will be able to take a tax-free income from it if you die before age 75. They could also take it as a tax-free lump sum subject to your remaining Lump Sum and Death Benefit Allowance (LSDBA). |
| Enhanced if you have health problems? | Yes | No |
Advantages of an annuity
- Certainty: You will know what your income is long into the future, giving you peace of mind in your retirement.
- You set the timescale: An annuity can either be for life and pay you an income no matter how long you live, or it can be for a set period.
- Joint-life annuity: A joint-life annuity means you can nominate a spouse or partner to receive income payments after you die.
- Higher income for those with health problems: If you suffer from a medical condition and have a lower life expectancy as a result, you could be entitled to a higher annuity income.
Downsides of an annuity
- Decision for life: Once you buy an annuity there is no turning back. You cannot cancel or alter the terms, or transfer to a drawdown plan.
- Inheritance: A single-life annuity cannot be passed on. Upon your death, your insurer will keep all the remaining funds.
- Inflation risk: If you choose a level annuity, there is a chance inflation could take away your income’s spending power.
- No growth: Unlike a drawdown that remains invested, an annuity has no chance for growth.
Should I choose an annuity or drawdown?
- Reasons to choose an annuity
An annuity will give you peace of mind that you will have an income for life, or for whatever term length you choose. While you cannot then switch to a drawdown product later, it will give you a secure source of income.
- Reasons to choose drawdown
The flexibility of a drawdown is a major benefit to this arrangement. It means you can access the funds you need to pay off your mortgage, buy a new car, or go on holiday and not worry about having to stick to an income limit.
Can I combine an annuity with drawdown?
Yes. It is possible to use some of your pension to buy an annuity and put the rest into drawdown. This gives you both the security of a guaranteed income, and the flexibility of taking the rest as and when you need it.