Annuity or Drawdown? – that is the question

15 August 2019

Annuity or Drawdown? – that is the question

It doesn’t matter if you are looking to convert your pension pot into income, considering a DB transfer or running a drawdown plan, one the most questions in financial planning is whether to buy an annuity or invest in a drawdown plan.

Before looking at this important question let’s be clear on the terminology.

Annuities

They are a type of insurance policy which converts a lump sum into regular income payments (normally monthly) for the rest of your life no matter how long you live.

For example if you have £ 100,000 in your pension pot and are 65 years of age with a spouse or partner 5 years younger, you could arrange a joint life annuity that pays £ 4,400 per annum for gross with level payments and 2/3rds payable to your partner if you predecease them.

If you want the income to keep place with inflation, the annual payments would be £ 2,800

Don’t forget your state pension or company final salary pension is just like an annuity because it pays a regular income for the rest of your life.

Drawdown

This is a type of investment plan where you invest your pension pot and then may income withdrawals.

You may actually be using a form of drawdown without even knowing about it. Think of your personal bank account; you pay your earnings into the bank and take money out to pay for things. If you take more out you earn you go into overdraft but if you spend less than you earn you have a positive balance.

Pension drawdown works in the same way except instead of having a salary you rely on investment growth to avoid reducing your pension savings.

For example, if you have £ 100,000 in your drawdown plan you can pay yourself a regular income of £4,000 per annum and you get 4% investment growth you will end the year with the same amount of pension pot. If you only get 3% growth you will reduce your pension pot by 1%.

Why is this question so important?

It is important because every year thousands of people must decide if it is better to have a regular guaranteed income over which they have no control or take their chances and have an income which they can control but is not guaranteed.

By control, I mean there is no flexibility to change the income payments from an annuity but you have complete flexibility over the amount of income you take from a drawdown plan. At the extreme you can take all your money out but you will pay tax at your marginal rate.

Its not just about income it is also about leaving money to your family.

With an annuity or company pension the income stops when you die, or your partner dies if a joint life annuity. But with a drawdown plan, when you die any money left in your pension pot can be left to whoever you nominate.

So, what is best – an annuity or drawdown?

It all depends on what you want. If you want a guaranteed income an annuity is probably the best bet. If you want the flexibility to spend your pension pot as you like and hopefully leave a lump sum to your family drawdown is probably the best bet.

But it is not as simple as that because drawdown is risky. With drawdown you run the risk of running out of income and having nothing left to leave to the family. If you invest in a drawdown plan and invest your money unwisely or there is a serious stock market crash, you may look back and wished you bought an annuity or stuck with your company pension.

How do you work out which option is best for you?

The short answer is to get expert financial advice from a firm like ours, Better Retirement. We have over 25 years’ experience in helping decide whether it is best to arrange an annuity or invest in drawdown, or in some cases, a combination of the two.

The longer answer is to be clear what your retirment objectives are and how much risk you can take. One of the problems is that many people want to have their cake and eat it – that is lots of guaranteed income, total flexibility and complete control. The problem is we can’t have our cake and eat it! Or can we?

Most Read:

Get A Free Guide

Our handy guide covers all your retirement options.

Read More...
Better Retirement have been helping people make the right decisions for over 25 years and we will be pleased to give you a free initial consultation.

Get In Touch:
01604 521356

Offices in London and Northampton

  • Better Retirement Group Ltd
  • 400 Pavilion Road
  • Northampton
  • NN4 7PA