Updated 03 December 2020
4min read
When accessing your pension, should you opt for drawdown or an annuity? It’s the retirement dilemma of our age: do you play it safe with a steady income for life, or go for flexibility and take a higher risk in the hope of receiving more?
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.
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.
Various different types of annuities are available. Some pay a fixed income, while others pay an income that increases over time (this can help fight inflation). You can also buy joint life annuities that cover both you and your spouse. Furthermore, if you have health problems you may be offered a more generous annuity (called an enhanced annuity).
Annuity income is taxed in the same way as ordinary income. Find out more about annuities.
The advantages of an annuity are:
The downsides of an annuity are:
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.
The advantages of drawdown are:
The downsides of drawdown are:
Here you can see the main features of these pension products rated side by side.
Feature |
Annuity |
Drawdown |
Guaranteed income? |
Yes |
No |
Reliability |
***** |
*** |
Ease of use |
***** |
*** |
Flexibility |
** |
***** |
Inheritability |
** |
***** |
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.
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.
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 drawdown scheme.
The second way is to start off 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 still.
You can find some good comparisons in this article, ‘What pension income will my £100,000 pot buy me?’
The surest way to make the right decision on how to access your pension is to speak first to an independent financial adviser, who will help you consider all the risks and benefits in light of your circumstances.
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