We all want to get the most from our hard-earned pension pot but everyone has a different appetite for risk. Whereas some people prefer a fixed income in retirement, others would rather draw out some of their pension while continuing to invest the rest in stocks and shares, which can go up or down. This is, broadly speaking, the difference between a pension annuity and drawdown, which we discuss in further detail below.
One of the most common options for someone reaching retirement age, a pension annuity provides a fixed income drawn from savings accrued during the working life of the holder.
On retirement, the full amount of a pension fund is withdrawn and used to purchase an annuity policy. After this time, you will receive a guaranteed, secure income each month until your death. The monthly payment cannot be altered and no large lump sum can be withdrawn.
An annuity is essentially a form of insurance, whereby the provider guarantees to pay a fixed amount only for the remainder of the lifetime of the holder. At this point, the policy ceases regardless of the amount left in the pot, which the provider retains, and no further payments are made to family members or loved ones. There is, however, the option of a joint annuity, whereby the partner who is left behind is partially protected.
A drawdown pension allows you to withdraw regular monthly or larger one-off sums from your fund while leaving the remainder in place.
A holder is free to withdraw funds as they choose, in some cases the full amount. In doing so, you take on greater responsibility, and risk, for the performance of those funds.
Any money that a holder elects to keep in their pension fund remains invested in shares on the stock exchange or other markets. It is therefore subject to potential gains or losses as market conditions dictate. You can also make further payments into the fund as you wish.
Whereas a drawdown is essentially an accessible pension pot functioning as a fund on the open market, an annuity is a fixed but secure monthly income source.
If you hold an annuity, you have almost no control over your monthly income and no option to take out large lump sums if you need an injection of cash. Drawdown pension holders, on the other hand, do have plenty of options. You can either leave all of your savings in place, draw a monthly income while leaving the remainder in play, or withdraw large sums to fund investment projects or simply enjoy.
Annuities provide the total stability of a fixed monthly income and are not subject to any external factors. Drawdown pensions can provide for regular monthly payments, but these can be adjusted upwards or downwards, and a fund will be affected, as any stock market investment is, by factors outside of a holder’s control.
It’s also worth noting when choosing your private pension that you are still eligible for the state pension as well. The government has produced some excellent guidance on this.
With an annuity, you can be completely confident that you will receive a fixed income for the remainder of your life, come what may. Especially in times of market volatility, an annuity is one of the surest ways of insulating oneself from wider global problems in financial markets.
The fixed nature of the payments also means that a holder will not be tempted to spend all their money. By not being able to withdraw any funds, or even adjust the amount upwards, there is no risk of making costly mistakes through bad investments or carefree spending.
On the other hand, pensioners with annuities have no room for manoeuvre when it comes to their retirement. You have security, but unless the fund is very large, the monthly income you generate is unlikely to be enough to allow large one-off investments, such as in property.
A further potential disadvantage in certain cases – but an advantage to the annuity provider – lies in the fact that it is in effect an insurance policy. Under a joint annuity, when a person dies, the funds can be transferred to a spouse or named person, who will receive a portion of the monthly payments. However if this option is not taken, the remainder of what is in the policy is lost when the holder dies and cannot be passed down to loved ones.
A pensioner with a drawdown can make their money work for them in far more ways than the fixed monthly income of an annuity allows. For example a drawdown pension holder might want to make withdrawals to buy property, support children who need financial help, or just enjoy their well-earned money on a bit of luxury in their retirement.
Furthermore, drawdown pensions have been designed for maximum flexibility, meaning you can withdraw or leave in as much as you choose. If you want to keep your funds out on the stock market, where they might continue to grow in value, you can do so, and reap the rewards. As such a drawdown is something of a hybrid investment and income stream all in one.
The downside to this is that all the while a fund is out on the markets, rather than locked away in an annuity, it can go down in value. Particularly at times like these, with so much uncertainty hanging over the financial markets, that is a risk even if you’re ultra-cautious.
With the option of withdrawing funds comes greater responsibility for those funds. There is always the risk of using a drawdown pension more as a bank account than a savings fund. The sum in a fund is finite. If it is withdrawn and not spent wisely, or if what is left in a fund loses value, the money can run out.
Ultimately it comes down to how a person plans to spend their retirement. There are lots of free resources out there which help you to make informed choices based on your situation, including this from Money Helper – but it’s always worth seeking independent advice.
If the priority is to be cautious and conservative, then an annuity is generally a good choice. If you are more inclined to enjoying your golden years, either through investments or pursuing new ventures such as travelling, or moving abroad, the drawdown option will give you that.
For the above reasons, it is better to go into a drawdown pension if you have some knowledge of financial markets, and a head for investing. Poor planning and bad decisions could quickly drain a drawdown fund, a factor compounded by market conditions outside of your control.
The short answer is yes: it doesn’t have to be annuity vs drawdown. This can either be done by simply holding two different pensions policies, one drawdown, one annuity, and thereby enjoying the advantages of having both.
Another option is to take a withdrawal from a drawdown pension to buy an annuity as well.
Whichever you choose, pension drawdown or annuity, or a combination of the two, there are lots of things to consider when making your decision. Money Helper explores when you should actually take your pension – and it’s not as straightforward a decision as it seems.
Money Helper has also produced a checklist for people approaching retirement age. And the government’s own website lists other ways in which you can get pension advice, whatever stage you are at.
Please be aware these articles are for general information purposes only and correct at time of printing. We will not accept responsibility for any errors made or actions taken by any readers that have acted on the information contained. Answers given are for guidance only and specific advice should be taken before acting on any of the suggestions made. All information is based on our understanding of current tax practices, which are subject to change. Always remember when investing, past performance is not necessarily a guide to future performance and the value of some investment units can fall as well as rise.
