A quick guide to Annuities vs Drawdown

12 January 2017

If you are due to retire soon then you may currently be negotiating the minefield of pension options in front of you – and the choice you potentially face between annuities and drawdown products.

Pension freedoms over the last year have dramatically changed the way retirement savings can be accessed and used. You can take 25 per cent of your fund tax-free  and the rest can be taken as either an annuity, drawdown or cash (taxed at your marginal rate) – or a combination of the three.

You might be wondering what the difference is between a traditional annuity and a drawdown product. So, to help you work out which might be best for you, here is our impartial quick guide to traditional annuities vs drawdown. 

So first… what is an annuity?

Many people rely on the financial security of a fixed monthly income, particularly if wanting to maintain a certain lifestyle in retirement that relies on a guaranteed income each month. 

An annuity is purchased with the money built up in your pension fund throughout your career. It converts your pension pot in to a guaranteed regular income every month for your whole life. 

With an annuity, if you pass away after five years, for example, your annuity provider would keep the remainder of your pension pot, unless you purchased additional death benefits at the outset. However, if you continue to live for forty years after retirement, you would continue to receive your guaranteed monthly income even if you have reached and surpassed the original value of your fund. 

Flexi-access drawdown (Drawdown)

Thanks to the increased flexibility of the recent reforms, you can keep your pension invested, take a tax-free cash sum and withdraw any level of income from your pension fund as and when you need it. 

Your fund remains invested so can continue to grow, and is available for the benefit of your loved ones on your death. Unlike an annuity, however, the income is not guaranteed and depends on investment performance. 

With a drawdown product you can still buy an annuity in the future, should annuity rates sufficiently improve or you qualify for an enhanced annuity on attractive terms.

How do they compare?

There are some significant risks to weigh up if you choose not to buy an annuity and instead leave your pension fund invested with a drawdown product.

As your pension remains invested, the value of your pension pot could decrease if the funds you have invested in do not go on to perform well, so they might not be able to sustain the amount of future income you need. Plus, if you withdraw too much you could deplete your pension fund.

However, one main benefit of drawdown is that when you pass away, your dependants or nominated beneficiaries will benefit from any remaining money from your pension pot – unlike with an annuity where any unused funds will be lost (unless written on a joint life basis or with value protection). 

With both options, the retirement income you take will be taxed at your marginal rate (the same way as employment income).  or drawdown

For ease, here is a summary of the benefits and drawbacks of traditional annuities vs drawdown…
                                                                 

It is also worth remembering that since the reforms of last year, some innovative new products have arrived to the market that offer a combination of your three main options; a ‘one-stop shop’, if you like, consisting of an annuity, drawdown and cash option – previously treated as separate products. 

If you still aren’t sure which product might be right for you, don’t worry. A retirement income specialist like Retirement Line will be able to explain all the options available to you, in a jargon-free way that you can understand. There is no obligation to proceed by talking to us, and you will never be under any pressure to make a decision.

To speak to one of our specialists today, or to request your free guide, call 0800 652 1316.