Annuity vs drawdown: your retirement income options

Retirement changes everything, including how you think about money. One of the first questions we get asked is this: annuity vs drawdown, which one is right for me?

It is a good question and one that did not even exist before 2015. Andrew is 65 and recently came to us with exactly that question. His case clearly explains both options.

What changed in 2015 and why it matters

Annuities were what everyone did at retirement. Then 2008 happened, and interest rates went close to zero. They stayed there for years. A £100,000 pot was suddenly generating as little as £3,000 a year. People were not happy.

The 2014 Budget scrapped the rules pushing retirees toward annuities, and by April 2015 through the Pension Freedom Act drawdown was open to everyone.

The annuity vs drawdown conversation started there and has not stopped since.

Annuity vs drawdown: what is an annuity?

An annuity is a simple trade. You hand a lump sum to an insurance company. They pay you a fixed income every month for life.

The money keeps coming regardless of markets or how long you live. You can add inflation protection so the income rises each year.

A joint policy keeps payments going to a partner after you are gone.

Andrew has £150,000 in a personal pension with Aegon. The rules allow him to take £37,500 of that completely free of tax.

He can use the remaining £112,500 to secure a guaranteed income for life.

Andrew has terminal health issues and therefore qualifies for an enhanced annuity, which pays a higher rate to account for a shorter life expectancy.

Andrew is likely to fall into that category, putting more money in his pocket each month.

The strength of an annuity is certainty. Andrew knows exactly what arrives in his account each month.

There are no investment decisions, no market risk, and no danger of the money running out. However, the trade off is that buying an annuity cannot be undone.

Once it is set up, that is it. That is precisely why taking proper advice beforehand matters so much.

Annuity vs drawdown: what is income drawdown?

With drawdown, the pension pot stays invested. Rather than handing money to an insurance company, the retiree takes an income directly from the fund whenever it suits them.

They choose the amounts that work for their situation, and the pot stays in the market with room to grow over time.

Of course, values can drop as well as rise.

Flexibility is the main draw of income drawdown. Income can go up or down depending on what life throws at you, and lump sums can be taken when needed.

Additionally, whatever remains in the pot when the retiree passes away can go to family members.

However, from April 2027 pension pots will fall within the scope of inheritance tax, so early planning in this area pays dividends.

For Andrew, the annuity vs drawdown question is straightforward. Drawdown introduces risks and complexities that do not suit his situation.

Furthermore, a financial advisor needs to watch and review an invested pension pot regularly.

Given his age and care home circumstances, therefore, a guaranteed income each month with no management required is a far more practical solution.

Annuity vs drawdown: which one is right?

There is no single correct answer. Nevertheless, the statistics since 2015 tell an interesting story.

When pension freedoms arrived, annuity take up dropped to around 10% almost overnight. Consequently, over 90% of those choosing an income option went into drawdown.

Years of poor annuity rates made the freedom on offer impossible to resist.

Even so, drawdown still dominates, accounting for 67% of retiree assets compared with just 11% in annuities.

Annuity purchase works well for those who want predictable income and no investment headaches. In contrast, drawdown works for those comfortable managing their finances and happy to accept some investment risk.

Moreover, a growing number of people split their pot between the two, using an annuity to cover essential costs while keeping the rest in drawdown for flexibility and potential growth.

A note on Andrew's other pensions

Andrew has three further pensions with Royal London totalling £32,000, and all three carry guaranteed annuity rates.

Importantly, these rates could deliver a substantially better income than anything on the open market today.

For that reason, these plans need separate specialist advice before anyone makes any decisions. Giving up these guarantees without understanding the impact could therefore cost Andrew a significant amount of income across his retirement.

Next steps

The annuity vs drawdown decision is one of the most important a retiree will make.

Consequently, a financial advisor will put Andrew's guaranteed annuity rates alongside current open market rates and work through the best approach across all four pensions.

Getting this right from the start puts Andrew in the strongest possible position as he moves into retirement.

If you would like to talk through your own annuity vs drawdown options, our team of financial advisors is ready to help.