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Pension drawdown vs an annuity

A guide to the key differences and benefits to consider when choosing between an annuity and pension drawdown.

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By Tony Stevens  | Pensions Expert

Updated: 4th July 2019* | Published: 17th April 2019

Annuity or drawdown pension? How to choose the best option for you.

We get quite a lot of enquiries from people who are on the verge of retirement and now want to consider the options with their pension fund; whether to choose a pension drawdown or an annuity?

When considering the difference between a drawdown or annuity pension, it’s important to have a clear understanding of the benefits of each option so you can make an informed choice that suits your own personal preference.

Fortunately, the advisors we work with are experts when it comes to pensions and can give you the right advice on which is best for your circumstances.

To assist you in this decision we have produced this guide to help you with your income drawdown or annuity purchase covering the following areas:

Once you’ve read through the details below, if you’d like to understand more about annuities and income drawdown make an enquiry and we can arrange for an expert to contact you directly.

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Can I use income drawdown or an annuity with any type of pension plan?

All personal (or private) pension plans are usually defined contribution schemes (also known as money purchase), therefore, if you have one of these plans you will have a choice between either purchasing an annuity or an income drawdown plan when you reach 55 years of age.

The other main type of pension is called a defined benefit scheme (more commonly known as a final salary pension). These type of schemes are based on the number of years service and will pay you a pension (based on a percentage of your final salary) once you reach a predetermined retirement age.

Final salary pension schemes do not allow you to purchase an annuity or use drawdown at retirement. The only way you could do this would be if you transferred your defined benefit fund to a defined contribution scheme.

This is usually not recommended as you would lose out on a number of ancillary benefits which typically outweigh what you could receive from a personal pension plan. That said, there are circumstances in which it might be viable, such as contracting a life-limiting illness or running into financial difficulties.

What is the difference between an annuity and income drawdown?

When giving consideration to whether you should choose an annuity or income drawdown with your retirement fund, it’s important to understand the key differences between the two options.

Do you want a guaranteed pension for life?

This is probably the main difference between the two options. An annuity can provide you with a guaranteed income either for the rest of your life (Lifetime Annuity) or fixed for a set number of years (Fixed Term Annuity).

Income drawdown will only provide an income for as long as there are funds still remaining in your pension pot. Once all of the funds have been used your income will stop.

Do you want to dictate how much pension you receive?

Another key difference which may determine whether you choose an annuity or drawdown pension is how and when you want to receive withdrawals. Income drawdown gives you complete control over when you want to receive pension payments whereas an annuity will make regular payments as agreed at the outset (either for life or for a fixed term).

There are also tax potential tax benefits to consider. For instance, with drawdown you can vary the amount you take which can give you control over how much tax you pay.

Do you want your family to inherit your pension fund when you die?

If you die with funds still remaining in your pension pot with income drawdown your family will inherit this money. If you purchase an annuity which is guaranteed for life then the income will cease at the point when you die unless you have a joint-life annuity where the surviving member will still receive an income.

Income drawdown vs annuity: do you want to retain control of your fund?

When you take income drawdown withdrawals the remaining funds can still benefit from investment growth. With an annuity you effectively handover control of your fund to your provider in exchange for an income for life or a fixed term.

If you’d like to know more about the key differences between a drawdown pension and an annuity make an enquiry and we can arrange for a specialist to get in touch.

Is a pension drawdown better than an annuity?

Many customers ask us is pension drawdown better than an annuity?” and there is neither a right or wrong answer to such a question - it really depends on whether a drawdown pension or annuity best suits your own personal preferences and circumstances.

Both options share common traits. You can take a 25% tax-free sum at outset from either an annuity or drawdown pension. The amount of income you receive is determined by the annuity or income drawdown rate tables used by your provider.  

In order to reach a more informed conclusion let’s look at the main benefits of each:

What are the main benefits of an annuity

Peace of mind

With either a Lifetime Annuity or a Fixed Term Annuity you have the peace of mind of knowing you will receive an income every month for the rest of your life or for a set period. This allows you to plan ahead and be able to budget accordingly knowing the money will never run out.

Different options available

Whilst a lifetime annuity is appealing for complete peace of mind, it is not the only option available to you. There are a few different variations, namely:

  • Fixed Term Annuity - offers a guaranteed income for a set period of time allowing you to avoid over-committing to a lifetime option
  • Enhanced Annuity - offers better annuity rates, therefore higher income, for those with particular health conditions
  • Escalating Annuity - offers the opportunity to increase your income in line with inflation

What are the main benefits of pension drawdown?

Flexibility

A pension drawdown offers you complete control of how much and when you withdraw your money. This allows you to control your pension fund and adapt your retirement income to changes in your life.

You may not need as much income during the early stages of your retirement but more as you get older. Pension drawdown will be able to cater for this requirement.

Inheritance

With a pension drawdown fund you will always know that should you die whilst there are funds remaining in your pension pot these funds can be passed on to a beneficiary of your choice.

Investment

Whether you are taking drawdown payments or not your pension pot has the opportunity to continue to grow depending on how well the underlying assets perform. Your money can go down as well as up, however, the ability to control where your retirement fund is invested can prove attractive to a lot of people.

Do I have to choose between an annuity or pension drawdown or can I do both?

It’s possible to do both. For example, you may decide to use some of your pension fund to purchase a fixed term annuity in order to ensure you have a guaranteed income for a set number of years then use the remaining pension fund for income drawdown as and when required.

Speak to a pensions expert about pension drawdown versus annuity - which choice is right for you?

Deciding what to do with your pension fund as you approach retirement is an incredibly important decision and one which requires careful thought. Lots of people choose to take professional advice beforehand.

The advisors we work with will not only work with you to make these initial decisions, but provide regular (usually annual) reviews of your pension investments to make sure they’re perfectly tailored to your needs and circumstances.

If you have questions and want to speak to an expert for the right advice, call Online Mortgage Advisor today on 0800 304 7880 or make an enquiry.

Then sit back and let us do all the hard work in finding the pensions advisor with the right expertise for your circumstances.  – We don’t charge a fee and there’s absolutely no obligation.

Updated: 4th July 2019
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FCA disclaimer

*Based on our research, the content contained in this article is accurate as of most recent time of writing. Lender criteria and policies change regularly so speak to one of the advisors we work with to confirm the most accurate up to date information. The info on the site is not tailored advice to each individual reader, and as such does not constitute financial advice. All advisors working with us are fully qualified to provide mortgage advice and work only for firms who are authorised and regulated by the Financial Conduct Authority. They will offer any advice specific to you and your needs. Some types of buy to let mortgages are not regulated by the FCA. Think carefully before securing other debts against your home. As a mortgage is secured against your home, it may be repossessed if you do not keep up with repayments on your mortgage. Equity released from your home will also be secured against it.

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