Drawdown vs Annuity
We take a look at these two popular forms of pension products
As we near the end of our working lives and have one eye on retirement, our pension savings goals change from "build my pot" to "how do I take my money".
Not too many years back, the most common thing to do was to exchange your fund for what is known as an annuity. In recent times, increased flexibility has meant that savers have more options available to them and with this, we have seen an increase in people moving away from annuities for newer options such as pension drawdown.
Before we start to look at a comparison between the two, let's take a look at their definitions.
What is an annuity?
An annuity is a financial product that takes your pension fund and exchanges it for a guaranteed income for the rest of your life, or a fixed period.
What are drawdown pensions?
Electing to drawdown your pension means to leave the fund invested and take chunks of your money as and when you need it.
So let's get to brass tax and look at the advantages and disadvantages of Drawdown vs Annuity.
Main Advantages of Annuities
ADVANTAGES
Annuities provide security of income, with no investment risk involved.
A lifetime annuity provides a guaranteed income payable for life.
You can also have fixed-term annuities, which provide income for a chosen term, at the end of which you can choose whether to purchase a new fixed-term annuity, purchase a lifetime annuity (or you can choose to have no maturity value at the end).
If you were to pass away, your annuity can provide a lifetime income to a spouse or lump sum to chosen beneficiaries if this option is selected at outset.
An annuity is based on your lifestyle and medical condition (drawdown is not), meaning you could potentially get an enhanced annuity and therefore have a higher lifetime income if, for example, you are not in good health.
Main Disadvantages of an Annuity
DISADVANTAGES
Inflexible - once you purchase an annuity you cannot change the amount of income you get.
Lifestyle based - if you are in good health or live an unhealthy lifestyle, you may get a lower income level.
The income from an annuity may not keep pace with inflation (unless the annuity is set up to increase each year and the increase rate matches or exceeds inflation).
You will not benefit from future growth on your pension fund and it is not usually possible to transfer your annuity once in payment.
In the event of death, depending upon the type of annuity you have purchased, benefits to your beneficiaries could be lower than those enjoyed under some of the other options available to you. The benefits may cease on death.
Now let’s look at what advantages and disadvantages drawdown pensions have to offer.
Main Advantages of Drawdown Pensions
ADVANTAGES
Drawdown provides the over 55's with increasingly desired pension flexibility. The Government has confirmed that the normal minimum pension age will rise to 57 in 2028.
The ability to change the amount of income you take as and when you please offers brilliant opportunities for retiree's.
Helpful for tax planning with the correct advice.
Drawdown also allows you to leave the remaining fund to your chosen beneficiaries on your death.
Any growth within the fund is free from capital gains tax, although it could be taxable when money is withdrawn from the fund.
Main Disadvantages of Drawdown Pensions
DISADVANTAGES
Risk - leaving your fund invested will expose it to fluctuations of the stock market, it will have the opportunity to grow but can also risk losing money if the markets were to dip.
Management - You will also have to take more time to manage your fund and levels of drawings you take from it. There may be additional costs to manage your fund such as ongoing adviser fees.
The levels of income provided may not be sustainable, so in other words your pension fund may run out.
If investment returns do not at least match the critical yield (in simple terms, the value of growth required to provide an equivalent income at the age you intend to purchase an annuity), your eventual income is likely to be less than that which could have been available via the annuity route.
Any monies drawdown from an existing Flexi-access drawdown plan and not spent as intended, could create an Inheritance Tax issue.
Similarities
There is one main similarity with the two options and that is with either options you can choose to take up to 25% of your fund as tax-free cash (in most cases, some have more than 25% if they have protected TFC).
When to start comparing how to take your money?
A sensible time to start weighing up which pension freedom option fits best with your situation would be
12 months away from when you plan to retire
Some of the more sophisticated pension funds will have been designed with a certain end goal in mind, so a good idea is to check this with your current pension provider/adviser.
Which is right for me?
Either product offers both advantages and disadvantages, selecting one product over the other will ultimately be a personal decision. For example, some might like the idea of managing their money, keeping an eye on their fund performance and making withdrawals, in which case drawdown might be right for them. However, another might lean towards annuity as the idea of having a guaranteed income without having to manage their plan could be more appealing.
In Summary
Question - "Drawdown vs Annuity" - which is best for me?
Answer - like with so many financial products, you need to compare the two, firstly from a high-level overview point of view. Ask yourself these types of questions:
Do you want to have a guaranteed income?
Would you be happy to leave your fund invested and expose it to risk?
Are you happy with not being able to take a larger chunk of money in retirement if you needed it? For example - granddaughters wedding, home improvements, holidays and travel?
As well as testing yourself against these "theoretical" questions, it is vital to look at some financial projections. You might find yourself leaning towards one product but then after seeing what this means in monetary terms, you could very well change your mind.
Want to see what a Drawdown Pension & Annuity could give you in retirement?...
During our Pension Discovery Meeting, we can provide you with a pension projection using our award-winning software. We will show you what income you could expect to get for both an Annuity & Drawdown.
You will be guided through this process by one of our expert pension advisers. To learn more, simply book in for an initial consultation.
This stage includes…
✓ Discuss your circumstances
✓ See your retirement projection
✓ Take account of your current pensions
✓ Annuity, Cashout, Drawdown comparison
✓ Access to retirement projection tool
If you’d like to take a closer look at our retirement options solution, you can book yourself in for a free, no obligation initial consultation.
“Jack Saunders was a great help very patient, and went though all my options very thoroughly, no pushing , we came to the conclusion which was very acceptable.”
Please note: The value of investments and the income derived from them can fall as well as rise. You may not get back what you invest.