Annuity vs drawdown: which best suits your retirement plans?
It’s one of life’s biggest financial decisions: choosing between annuity vs drawdown. Here’s a summary of the points of comparison between annuity vs drawdown.
Annuity vs drawdown: which gives you the most security?
You don’t have a crystal ball – and that makes it hard to judge with certainty how much money you will need to fund your retirement years. So where do you start?
The first thing to consider is your appetite for risk.
Annuity provides a level of financial security that’s compelling for many. In a nutshell: in exchange for giving up your pension savings, you get a guaranteed annual income for life. That means you have the certainty of the same income – year after year – no matter how far you go into your retirement years.
With drawdown, your financial pot is finite. Once it’s gone, it’s gone. That means you have to rely on the pension savings that you have stowed away to sustain your retirement years – and it’s important to pace yourself. If your rate of withdrawal is faster than your pot’s rate of growth (which may be reliant on the stock market) then your capital sum decreases and – eventually – your funds will run out.
Of course, you can explore wealth management options to encourage your money to go further. But you may not want to shoulder that responsibility.
(You can always seek independent advice, of course.)
Flexibility and freedom
Maybe you are excited by having the freedom to manage your own retirement provisions. You have worked hard to build a healthy pot, and you want to be in charge of how you use it. Drawdown gives you that flexibility. Generally speaking you can withdraw as much money from your pot as you wish each year – though some scheme providers impose maximum limits. Example: if you want to withdraw £22,500 one year and then £7,000 the following year, that’s not a problem. And what you do with that money is up to you. Invest it. Spend it. You’re in charge.
In short: drawdown gives you flexibility and freedom. But before you steam headlong down the drawdown path, it’s worth noting that annuity funds aren’t totally rigid and inflexible. For example, an investment-linked annuity will give you a variable level of income based on your investment choices. Or you could plump for an escalating annuity, where your annual income rises each year to offset inflation.
Annuity vs drawdown: which option makes your money go further?
It depends. If your pension fund is well invested in markets that perform strongly, drawdown is more likely to give you a larger annual income than your comparative annuity payment. But everything depends on how your investments perform – and, again, that depends on the markets as well as your appetite for risk.
Get a tax-free lump sum
Lots of people like giving themselves a well-deserved treat to celebrate the arrival of their retirement. So whether you want to cruise the Aegean or fancy a new convertible in your driveway, both drawdown and annuity allow you to take up to 25% of your pension pot as a lump sum – without paying any tax on your pay out.
Of course, the more you leave in your pension pot, the more growth potential it has/more value for annuity. So just because you can withdraw a tax-free lump sum, it doesn’t mean you should. It all depends on your personal ambitions for your retirement.
After you have gone…
Nobody likes to think of their ultimate fate, but it’s an important part of deciding whether drawdown or annuity is best for you – especially when you are making considerations for your nearest and dearest.
With drawdown, the entire remaining value of your pot can be passed on to your beneficiaries, subject to tax charges that may apply.
Annuity on the other hand has a clear rule: it dies when you do (unless you have a joint annuity shared with a spouse, or an annuity fund with ‘value protection’ – which can be costly).
The key point is this: if you choose annuity and die prematurely, you will have traded the entire value of your pension pot on just a few years of income. Whereas with drawdown, anything that’s left in your pension pot after you’ve gone can be passed to your beneficiaries.
Annuity vs drawdown: is there a way to have the best of both worlds?
Choosing whether annuity or drawdown is best for your retirement plans depends entirely on your personal circumstances. There are benefits and drawbacks to each option. But what if you could blend each option? Well, there are hybrid products that provide a combination of guaranteed lifetime income with an element of drawdown flexibility. The downside? These products can be expensive, so you have to weigh up the benefits carefully.
Another way of getting the benefits of both drawdown and annuity is to begin with a drawdown fund and switch to annuity later, or purchase an annuity with some of your fund, rather than all of it. It can make good sense if you want to continue working part-time during the early years of your retirement, or if you have alternative sources of income from other investments.
Annuity vs drawdown: the choice is yours
The truth is that there’s lots to consider with annuity vs drawdown – and what works best for one person won’t necessarily work for you. It’s a big decision and accredited independent financial advice can be invaluable when – essentially – you are gambling with your future financial security.
We can help. Our advisers have the experience to lay out your options and help you make a decision with confidence. So you can get back to planning the happy retirement you deserve.