Annuity vs drawdown: what's the difference and which is best?
Compare drawdown vs annuities to determine which option is best for managing your pension, including the benefits and drawbacks of each.
When accessing your pension, should you opt for drawdown or an annuity?
Do you play it safe with a steady income for life or a fixed period, or choose flexibility and take on more risk in the hope of receiving more income?
If you’re approaching retirement, you’ve probably been saving up carefully for your whole working life.
However, the choices you make next with your pension are critical. It’s important to take your time with these decisions, as there’s no going back once you buy an annuity. It's well worth getting advice before you take the plunge.
This side-by-side comparison of annuities and drawdown will familiarise you with the pros and cons of each, helping you to make the right choices when you access your pension.
Find out more about the key differences between a drawdown and an annuity.
An annuity is a product that pays you a guaranteed income for life.
Drawdown is a way to take an income from a pension pot that stays invested in the stock market.
There are pros and cons of annuities and drawdowns to consider.
A financial adviser can help you find the best pension withdrawal option for your needs.
What is an annuity?
An annuity is a product that pays you a guaranteed income for life.
It is a contract with the annuity provider (who will be an insurance company) to provide you with this income, in exchange for a lump sum at the start – which usually comes from your pension pot.
The annuity income is not limited by a pot of money, so will continue paying out until you die. This means that if you live a long time, you may get back more than you paid for it.
It’s worth knowing that annuity income is subject to income tax in the same way as ordinary income, although you won’t have to pay national insurance. Find out more about annuities.
There are various different types of annuities. Here’s a summary of the main features.
Types of annuity | Features | Benefits |
|---|---|---|
Level or fixed income | Pays exactly the same amount for life with no inflation protection | This will pay out at a higher rate than an inflation- linked annuity |
Escalating/inflation linked | Pay an income that increases over time (this can help fight inflation) | You will received a lower income initially but a higher income in time |
Joint life annuity | You can buy an option that will still pay out a lower amount to your partner if you die first | This suits couples where one partner relies on the other’s pension income |
Enhanced annuity | If you have health problems you may be offered a more generous annuity | People with a health condition can receive more income |
Guaranteed period | Some annuities pay out for a guaranteed period, even if you die within this period | This means you won’t lose out as much if you pass away soon after buying the annuity |
Why do annuity rates change?
Annuity rates are riding high, currently hovering at their highest level in around 18 years.
That’s because annuity rates are closely linked to interest rates, which have risen in recent years.
Providers buy gilts to fund their customers’ annuity income, so consequently, annuity rates rise when gilt yields rise.
According to Sharing Pensions, a 65-year-old can currently buy a £7,880 annual level annuity income in exchange for a £100,000 pension pot.
The same pension pot would buy them a £5,430 annuity income if they opt for an annuity with inflation protection that pays 50% to a surviving partner.
What are the pros and cons of an annuity?
There are both advantages and disadvantages of annuities that are worth considering:
Pros | Cons | |
|---|---|---|
Simplicity | Once set up, it needs no managing | Key decisions need to be made when setting up your annuity |
Guaranteed income for life | You receive a fixed income that is guaranteed and will never run out | Your income is limited by the annuity rates on offer (which may or may not be generous). You have no flexibility to withdraw additional amounts |
Predictability | You receive a known income that remains the same. It is unaffected by changes in the stock market or economy. You have the option of receiving an inflation-protected annuity | A level annuity means your spending power decreases and doesn’t keep pace with inflation |
Inheritance | You can choose a joint-life annuity that continues to pay out to your partner on your death | An annuity can’t be passed on to your children or other heirs, unlike a drawdown pension pot |
Flexibility | Not applicable as annuities are not flexible | Your income is inflexible. Once you’ve bought an annuity, you can’t change your mind or trade it in |
What is drawdown pension?
Drawdown is a way to take an income from a pension pot that stays invested in the stock market.
You can draw out as much or as little as you like (provided the money is there), and these withdrawals are taxed as income.
Any unspent funds can be passed on tax-free to your beneficiaries when you die. Find out more about drawdown.
Bear in mind that the tax rules on inheriting a pension are changing.
Pensions are currently free from inheritance tax, but from April 2027, pensions will be included as part of your taxable estate.
While spouses can still pass on wealth tax-free, children could face a 40% inheritance tax bill on inherited pension assets if the total estate exceeds the threshold.
What are the pros and cons of drawdown?
As with annuities, there are both advantages and disadvantages of drawdown you need to consider.
Pros | Cons | |
|---|---|---|
Flexibility | You can increase (or decrease) your income whenever you like and take larger lump sums if you wish | There is no guarantee you will get a better income than from an annuity |
Control | You keep control of your pension pot and still have the option to buy an annuity later | Although you have control, a drawdown scheme needs ongoing management by you or your financial adviser |
No guarantees | Although there are no guarantees, you do still have the option to buy an annuity later with your drawdown pension | There is a risk your money runs out completely, especially if you choose a high withdrawal rate or live for a long time. Your pension pot stays invested, so it is vulnerable to stock market volatility. |
Inheritance | Your beneficiaries can inherit any remaining funds, whereas an annuity dies with you. Please note that inherited pensions are subject to inheritance tax from April 2027 | Your partner won’t inherit a guaranteed income. This is possible to achieve with a joint-life annuity |
How do annuities compare with drawdown?
Here you can see the main features of these pension products rated side by side.
Feature | Annuity | Drawdown |
|---|---|---|
Guaranteed income? | Yes | No |
Reliability | Guaranteed set income | Pension can run out if not managed |
Ease of use | No management needed | Ongoing management needed |
Flexibility | Income limited by annuity rates | Income can be increased or decreased as needed |
Can this be inherited? | No | Yes |
Can this be enhanced if you have health problems? | Yes | No |
The final point of comparison is the overall level of income you can expect from an annuity or from drawdown. Here, it is impossible to give a definite answer.
During periods of stock market growth, you could expect higher income from drawdown than from an annuity.
But when stock markets dip, they can shrink your drawdown pot by a large amount, reducing both your income and how long it might last.
You need to be aware of this risk when considering drawdown as an option.
Should I choose an annuity or drawdown?
The question of whether drawdown or an annuity is better will depend on your own individual circumstances.
Here are the main things that might influence your decision.
Reasons to choose an annuity
You like the reassurance that comes from a guaranteed income for life
You don’t want the burden of managing your pension
You expect to live a long time
You don’t expect your spending needs to vary much over time
Reasons to choose drawdown
You are prepared to take some risk in return for a potentially higher income
You expect your spending needs to vary over time
You want access to larger sums in an emergency
You hope to leave your family a larger inheritance if you die prematurely
Can I combine an annuity with drawdown?
The question ‘Annuity or drawdown?’ is often presented as an either-or choice, but in practice there is no reason why you can’t have both.
A combination of the two may provide you with the right balance of flexibility and security that you need.
There are two main ways in which you could combine drawdown with an annuity.
The first is simply to divide your pension pot in two (perhaps equally, perhaps not) and buy an annuity with one portion, and leave the other invested in a drawdown scheme.
For example, you could buy an annuity to cover your basic expenses, and leave the rest of your pension pot invested to continue benefitting from investment growth.
The second way is to start with all of your pot in drawdown, and buy an annuity later in retirement with all or some of the remaining pot.
Why wait? The idea is that when you are older you should get a more generous annuity, and if you have some health issues by then, it may be more generous.
Your lump sum and death benefit allowance (LSDBA) of £1,073,100 will reduce your tax burden when withdrawing pension funds and help to maximise your savings.
The surest way to make the right decision on accessing your pension is to speak first to a financial adviser, who will help you consider all the risks and benefits in light of your circumstances.
If you found this article useful, you might also find our article on the best drawdown pension providers informative, too.
Get expert pension withdrawal advice
Annuities and drawdown schemes both have their pros and cons.
While annuities offer a guaranteed income without management, their income is limited by available annuity rates and cannot be passed on to your beneficiaries as an inheritance.
Drawdown schemes allow your beneficiaries to inherit unused funds and enable you to increase or decrease your income, but they require ongoing management and may run out if not managed effectively.
Alternatively, you could consider splitting your pension between an annuity and a drawdown scheme to benefit from both.
Let Unbiased put you in touch with an expert financial adviser who can help you find the best pension withdrawal option for your needs.
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