Annuity vs drawdown – two ways to take your pension money
When approaching retirement one of your main decisions will be how to take money from your pension. Explore the differences between drawdown and an annuity here.
Key points:
- With an annuity, you’ll hand over some, or all, of your pension pot and it will pay a set amount either monthly or yearly until you pass away.
- Drawdown is a flexible way of taking as little or as much as you need without disturbing the rest of your pension pot.
- Depending on your retirement goals, opting for both a pension annuity and income drawdown could be the best outcome.
There are a few options to choose from, but some of the most common choices are pension annuities and income drawdown. In this article, we’ll go into the meaning of both, and then talk about the pros and cons of each option. This can then help you make an informed decision based on your retirement goals.
Understanding pension annuities
An annuity is often seen as a ‘traditional pension’. You’ll hand over some or all of the pension you’ve been building up and, in exchange, it will pay a regular income either monthly or yearly until you pass away. When you apply for an annuity, you will be given the option to take your 25% tax-free lump sum before the annuity is set up, or you can choose not to take any or all of your tax-free lump sum and use it to boost your income payments.
As payments from a pension annuity are part of your taxable income, tax may be taken from them. They are subject to the PAYE regulations, like income from employment. Annuity payments are subject to PAYE regulations, so HMRC will give your annuity provider a tax code which is intended to mean that you pay the right amount of tax as your annuity income is paid. HMRC can still require you to pay any tax still owing, or you may have to claim a refund from HMRC if you have paid too much tax. If HMRC require you to make one, you will also need to include your annuity income and the tax paid in your self-assessment.
The income you’ll receive depends on a few factors:
- The value of your pension
- Your age
- Your health
- The quote from the annuity provider
- The current interest rates
- Whether you’d like to provide an income for any dependents in the event of your death
- Whether you would like your income to increase
| Pros | Cons |
|---|---|
| Financial security Annuities offer a guaranteed income for life. With knowing you have a reliable income you can plan ahead, have the knowledge of what's coming in every month and make plans for home improvements or a well deserved holiday. You may just enjoy the knowledge of what’s coming in every month. | Lack of flexibility Annuities are for life so once you’ve bought one, it can’t be changed or cashed in. This limits how much you can change your income to match your needs. |
| Protection against up and down markets The income from annuities isn’t affected by market changes. So, you’re typically shielded from investment risks. At Aviva, we don’t offer investment-linked annuities. | Potential for inflation risk A fixed income may not keep pace with inflation. This could impact your day-to-day spending power. You can choose to protect your annuity income against inflation, but this may reduce the amount you get at the start. |
| Boosted income potential Your health may mean you’re eligible for an enhanced annuity. When getting a quote for an annuity make sure you disclose anything that may affect your life expectancy. | It’s a long-term commitment When you're thinking about jumping into the annuity pool, remember: you're diving into a lifelong adventure! |
A retirement income you can count on
Buying an Aviva annuity means guaranteed regular income for the rest of your life.
Understanding income drawdown
Drawdown is a way of letting you take out what you need from your pension in amounts that you can control. It’s a flexible way of taking as little or as much as you need without disturbing the rest of your pension pot. This means that the rest of your pension will stay invested and can still go down or up in value. You can tailor the withdrawals to suit you by taking out small amounts as and when you need, or by taking out a lump sum all in one go. Your withdrawals from your drawdown pot are treated as income, so you will be required to pay tax on them. You’ll also have the option to take a 25% tax-free lump sum regardless of how you choose to withdraw your money.
| Pros | Cons |
|---|---|
| Potential for more When in drawdown, your money will still be working and can grow (but it can also fall) as your money continues to be invested. At any point you can change your investment strategy, that way you can stay in an area that fits your risk appetite | Investment risk As you’re responsible for managing your investments, there’s a risk of the markets performing badly, meaning the value of your pension can go down. So, you could end up losing more than you’ve put in. If you aren’t into investments or aren’t receiving financial advice on your pension, you could end up making a poor investment choice. Pensions need careful monitoring and an understanding of the investment market to make the most of your money. |
| Adjustable income Drawdown allows you to vary the amount and frequency of your withdrawals, so you can align your income with your retirement lifestyle. Meaning if you need a top-up to help you get through a rainy day or buy a new car, you have that flexibility. Don’t forget that all income will be assessed for tax. | Your money could run out With a drawdown option, there’s a risk you’ll outlive your retirement savings. If you withdraw too much too quickly, or the investment under performs, your retirement funds could run dry. |
| Inheritance planning When in drawdown, you can pass on any remaining pension funds to next of kin or your beneficiaries when you die. This option allows you to consider the potential financial wellbeing of your loved ones. |
See whether drawdown can work for you with our retirement planner.
Tax rules are subject to change and depend on individual circumstances.
Consider choosing both annuity and drawdown
In some cases, opting for both a pension annuity and income drawdown could be the best outcome, but it will depend on your circumstances, retirement goals, and preferences. If you opt for a traditional annuity it could give you the comfort of a fixed baseline income so you know what you will be getting. Staying invested in the market by leaving some of your fund in a drawdown option gives you access to a lump sum and some flexibility around how you spend it.
If you’re still scratching your head, financial advice may be the next option for you.
Seeking advice from a financial adviser can help you navigate these options and make an informed decision that aligns with your unique situation. You may be charged for their services, so keep this in mind when you’re searching for the right adviser.
If you’re 50 or over, you can get impartial and specialist guidance on your retirement options using Pension Wise from MoneyHelper. It's backed by the government and completely free. Give them a ring on 0800 138 3944 or visit their website for more details.
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