As you approach retirement, one of the main decisions you'll have to make is how to take out the money you've paid into your pension. 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 set amount 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 use it to boost your monthly income payments. Because this is treated as income you will be required to pay tax on any monies received. This is normally taken care of by your provider so you won’t have to worry about it. 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
| Pros | Cons |
|---|---|
Financial security Annuities offer a guaranteed income for life. With a reliable income, treats may come more easily, whether it be making home improvements or taking yourself on that 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 usually 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 unless it is a variable annuity. 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! |
To see how much you could get, try our annuity calculator.
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 as well as up. 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.
Choosing between a pension annuity and income drawdown depends on your circumstances, retirement goals, and preferences. Annuities offer stability and a guaranteed income, while drawdown gives you flexibility, control over investments, and access to lump sums. Tax rules are subject to change and depend on individual circumstances.
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 advice 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.
Want to know more about your options?
Learn more about getting your retirement plans in order, from budgeting effectively to picking your investments.
Pension annuity articles
Take a look at our helpful articles and guides.
Enhanced annuity – What they are and how to get one?
An enhanced annuity could be a way to boost your retirement income, this article talks abut how you may be eligible for more than you think at retirement, and exactly how to check.
What is an annuity?
An annuity converts your savings or pension pot into a low risk guaranteed income for your retirement. See how annuities work, and if it could be right for you.
How annuity rates are calculated
Annuities give you a guaranteed income for the rest of your life. But exactly how much could you get?
When do annuities make sense?
Annuities can provide a stable income for your retirement, but they aren’t the only option. Find out if they’re the right choice for you.