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Since we published this article, there has been a development on the issue of taxation and pension income. In the Budget of 30 October 2024, the government announced that pension savings will be considered part of someone’s estate and liable to inheritance tax (IHT) from April 2027. This will be within existing IHT rules: IHT is not payable by a person’s spouse or civil partner, and is only typically payable on estates over relevant IHT thresholds.
Another aspect of inherited pensions is income tax. Currently, if you pass away before age 75 any pension funds or annuity income your beneficiaries receive is free of income tax, whereas they are liable for income tax at their marginal rate if you die after age 75. Retirement Line’s understanding is that beneficiaries may still be liable for income tax on inherited pension income from April 2027, although it isn’t clear whether the ‘age 75’ rule will remain.
More information will be available following a government consultation period that will run until early 2025. We are monitoring this issue and will report on it once the matter is clarified. Please see our Budget report for more information: Budget 2024 – pensions brought into inheritance tax from 2027.
Page updated: 14th February 2024
Deciding how to receive the money you have saved into your pension funds over your career is one of the most important financial decisions you will have to make.
Since the pension reforms came into play in April 2015, a number of flexible options have become popular with those choosing not to commit straight away to a lifetime annuity, now that they no longer have to.
If you are looking for a retirement income product that will allow you to access your tax-free cash now, whilst deferring your decision to commit to a lifetime annuity, there are two main type of products you may wish to consider:
We explain the difference between fixed term annuities and drawdown below, together with a table to compare them. Of course, for more in-depth information on fixed-term annuity vs drawdown, or any other retirement income products, then you might wish to seek the assistance of a specialist in retirement income.
Fixed-term annuities share some of the characteristics of both lifetime annuities and drawdown.
From the age of 55 (57 from April 2028), if you are unwilling or not yet ready to commit to a lifetime annuity, you could consider a fixed term annuity which pays you a regular income for a set period of time. You can choose the amount of income you receive and can specify your preferred term between one and twenty-five years. By taking the payments spread over several tax years, it can be potentially more tax efficient than if taken as one lump sum.
At the end of your fixed period, you will receive a guaranteed lump sum of money, often referred to as your ‘guaranteed maturity amount or value’. At this point you decide on your future choice of retirement income product (such as another fixed term annuity, or a lifetime annuity), or you may choose to take your remaining fund as cash.
This product may be a good option for you if you expect annuity rates to improve or because you feel you might qualify for an enhanced annuity in the future. Some retirees also use a fixed-term annuity to bridge the gap between early retirement and when they start receiving their State Pension.
You can use our free annuity calculator to see how much income you could secure with an annuity - or call us today on 0800 652 1316 or request a callback and one of our friendly team will be here to help.
If you are looking to take an income and not be limited by annuity rates at all, you may want to consider Flexi-Access Drawdown (also known as just ‘drawdown’). This allows you to keep your funds invested, where you will be able to draw any amount over the period you choose.
Assuming your funds last long enough (which of course they may not) then you can remain with this one product for the remainder of your life if you choose to.
As with an annuity, you will typically be able to take 25% of your pension savings tax-free. Any income you take after that will be taxable at your marginal rate.
The amount of tax you will pay depends on how much income you receive that year and your tax rate. For this reason, drawdown might be helpful in allowing you to control your tax payments, as you can limit cash withdrawals from your fund to keep below higher rate bands.
When opting for drawdown you need to be comfortable with investment risk and that the value of your fund (and therefore future income) may go down.
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Is drawdown better than annuity income? Or would an annuity work best for you? The answer depends on your unique financial situation and risk tolerance. Remember that each option comes with its own set of advantages and drawbacks, catering to different financial goals and preferences.
Taking the time to make the right decision for your individual wants and goals is important. Do remember though, you don’t have to exclusively choose between one option or the other. You could select a fixed-term annuity for some of your pension fund and drawdown for the rest.
Use our comparison table below to see if either, or both, of these options might suit you.
| Fixed-term Annuities | Flexi-Access Drawdown |
| Take up to 25% tax-free cash – no opportunity to take further tax-free cash after this point. | Take up to 25% tax-free cash – defer some if you wish. |
| Offers a regular income for a set amount of time, allowing you to budget. | Pay yourself an income of any amount whenever you wish. |
| Returns a known guaranteed maturity sum at the end of the chosen term, which can be re-invested into another fixed term annuity, any other type of retirement product, or taken as cash. | Keep your fund invested, with the potential to keep on growing. |
| Potentially benefit from increased annuity rates at the end of the fixed term as you will be older and with the possibility of qualifying for an enhanced annuity. | Buy an annuity in the future should annuity rates sufficiently improve or you qualify for an enhanced annuity on attractive terms. |
| Annuity rates may be lower in the future meaning the guaranteed maturity sum may not be adequate to provide a similar level of income that a conventional annuity would pay, if purchased today. | Your fund is invested and subject to uncertain investment return, so is a high risk option as your income is not secure. The value of your fund can fall and at worst, your income can run out. |
| The higher the income selected at outset, the lower the guaranteed maturity sum will be at the end of the term. This in turn will reduce the future level of income you can obtain. | High income withdrawals or poor investment returns could eliminate your fund. |
| Death benefits can be built into your annuity to enable your beneficiaries to inherit from your fund. Once selected at outset, benefits cannot be changed during the plan term. | You can pass on the value of your fund to your loved ones when you die, usually free from inheritance tax. |
As you can see from the above table, there are key differences between annuity and drawdown options.
To help you further compare these two products, here are some of the main fixed-term annuity v drawdown pros and cons:
Guaranteed income for the term, unaffected by interest rate changes or stock market volatility.
Choose how long your term lasts.
Choose how you use any guaranteed maturity value at the end of the term.
Once set up, it needs no managing.
Death benefits can enable your loved ones to benefit from your fund.
No annual charges, unlike drawdown.
You won’t typically be able to end or make changes to your fixed-term annuity once in place.
Your level of income depends on the current annuity rate and you won’t benefit from future rate increases.
You won’t benefit from any investment growth during your fixed term.
Any guaranteed maturity value may not be sufficient to meet your retirement income needs at maturity.
Modify your income depending on your circumstances at the time.
Your investments can continue to grow and you have control over them.
Option to withdraw all your money or purchase an annuity at any time.
Leave your remaining fund to your beneficiaries when you pass away.
Investment risk as your fund value could rise or fall.
Accessing too much of your cash or poor investment performance could see you running out of money.
Annual charges to your drawdown fund manager apply.
There’s no guarantee that you will get a higher income than if you had arranged an annuity.
Deciding if a fixed-term annuity or drawdown is best for you really depends on your own financial goals, risk tolerance and personal preferences. Here are some factors you might want to consider:
Income stability. If a stable and guaranteed income is important to you then an annuity might be more suitable.
Investment management. If you want all or some of your fund to remain invested and wish to actively manage your investments for now, drawdown might be a good fit for you.
Risk tolerance. Consider your risk tolerance and willingness to accept market volatility. Annuities are generally considered low-risk, offering a predictable income stream, while drawdown involves market risk.
Estate planning. Consider how each option aligns with your estate planning goals. If leaving your remaining pension fund to your beneficiaries is important to you then there may be more potential to do this with drawdown. However, you can also select death benefits with fixed-term annuities.
Ultimately, the ‘best’ option depends on your unique financial situation and objectives. You may find a balanced approach, choosing an annuity and drawdown combined, to be a suitable strategy as you can leave some of your fund invested while enjoying a guaranteed income from your annuity.
Everybody’s circumstances are unique. It's essential to carefully evaluate your options and seek professional advice or guidance to make the most informed decision for your retirement plan.
Do you want to leave an income or a lump sum from your pension fund to someone when you pass away? If so, you might want to spend a little extra time understanding the annuity vs. drawdown death benefits.
If you purchase a fixed-term annuity, there are ways to ensure that your spouse, partner or other named person/s can still benefit from your remaining funds.
At the point of setting it up, you can choose from three main types of annuity death benefits: a joint life annuity, a guarantee period or value protection.
Remember though, selecting death benefits may reduce the level of income you receive from your annuity. The more money you want your beneficiary to receive after your death, the more your own income will reduce.
If you pass away with funds in a drawdown scheme then the remainder of your pension can be left to your beneficiaries. However, the age at which you pass away is important.
If you pass away before turning 75 then you can pass on your remaining pension fund as either a tax-free lump sum or as income, depending on your pension provider.
If you pass away on or after your 75th birthday then the lump sum or income will be taxed at your beneficiary’s marginal rate of income tax.
We hope the above information has given you a good understanding of the main differences between a fixed-term annuity vs drawdown.
If you want to look further into whether an annuity is a viable option for taking your retirement income, Retirement Line is here to help. As the UK’s largest pension annuity broker*, we offer a full annuity service. We can provide you with annuity quotes from leading providers, help you compare annuity rates, and help to arrange your retirement income for you if you decide to proceed and buy an annuity through ourselves
Retirement Line work on a non-advised basis. If you are at all unsure of which options suit you, you should seek regulated advice. If you wish, Retirement Line can introduce you to an independent financial adviser.
Q. What does Martin Lewis say about annuity vs drawdown?
A: Whilst Martin Lewis doesn’t seem to have directly compared the difference between annuity and drawdown, nor go into any detail on either product, he does offer some useful insights on annuities to prospective retirees.
For instance, in his ‘Martin’s 18 pension pumpers’ article he says that annuities “have become an option again” following the annuity rate rises in recent years. He points out that rates rose from 4.95% in January 2018 to 6.3% in April 2023.
Martin also offers a couple of key rules when considering annuities. The first is to compare annuity quotes rather than simply accepting an annuity from your current pension provider. We would add that by using a specialist annuity comparison service such as Retirement Line, you could boost your retirement income by potentially thousands of pounds.
His second key rule on annuities is about enhanced annuities. If you have certain health issues or have a history of smoking then you might qualify for a higher annuity rate. This could see you achieving a higher retirement income for life. Again, Retirement Line can provide more information and check your eligibility for enhanced rates.
It is important to compare annuity rates AND explore the possibility of an enhanced annuity when comparing your potential income from an annuity vs drawdown.
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Retirement Line Limited is Authorised and Regulated by the Financial Conduct Authority, FCA No. 726601. Retirement Line Limited is registered in England and Wales, registration No. 6976976. Registered Office: 52 Forder Way, Hampton, Peterborough, PE7 8JB
*Equifax Touchstone pension income and annuity sales figures 2018 to 2020. Matrix Financial Solutions Inc annuity sales figures 2021 to 2022.
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