Working out whether to use your pension savings to buy an annuity (or income for life) or to draw an income from it as and when you need it is rarely an easy decision.
Whilst the thought of having a guaranteed amount of money coming in each year from an annuity is appealing for most of us, so is the thought of your pension savings continuing to grow and having the flexibility to take money out when you want.
The good news is that it doesn’t necessarily have to be an either/ or decision and, depending on your current circumstances, you may find that a mix and match approach could be right for you.
Here, we look at some of the pros and cons of both annuities and drawdown, to help you work out which option might be best for you.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
How do annuities work?
Annuities have previously been shunned by many people because you effectively ‘lose’ your pension fund when you buy one (namely, you hand it over to the annuity provider in return for the income you get every month).
However, they are currently the only product available that guarantees to pay you an income in retirement, no matter how long you live.
If you die after you’ve bought an annuity, however, your dependents won’t receive any of the money. The only exception to this is if you buy a product called a ‘guaranteed annuity’, which guarantees to pay an income for a specified term, normally something like 10 years. If you die during that term your husband or partner can receive that income or it can be paid into your estate.
There are lots of different variations of annuity and the choices can be confusing. For example, enhanced annuities are products that pay a higher income to people who have a medical illness, such as high blood pressure or have previously had a stroke, or who smoke, which means they could qualify for a higher income every year for the rest of their life.
It’s also worth knowing the difference between level annuities, which mean that your income won’t rise with inflation and their spending power will dramatically decrease over the term of their retirement, and inflation-linked annuities, which provide an income that increases in line with living costs.
Whichever type of annuity you’re considering, it’s essential that you don’t rush into your purchase, and that you shop around for the best possible deal, or you could end up missing out on a higher retirement income. Learn more about this in our article Why it pays to shop around for your annuity. You can find further information about how annuities work in our guide Annuities explained.
What is drawdown?
Drawdown – often known as flexible drawdown or flexi-access drawdown – as the name suggests, is a way of drawing an income from your pension as and when you need it.
The remainder of your pension stays invested, either with your current pension provider or another provider, with the aim that you’ll benefit from any potential growth in the value of your investments over time. Of course, your pension savings could fall as well as rise in value, so if you’re considering drawdown, you must be comfortable accepting the risks involved. Learn more in our guide What’s your attitude to risk?
Bear in mind too that the more income you take from your pension, the less will be left to grow for the future (that might sound obvious, but it’s important to think long term with your pension fund).
In short, the big advantage of using drawdown is that it gives you more freedom and flexibility, but the risk is that you run out of money because you live for longer than you expect. For example, according to Hargreaves Lansdown, someone aged 65 withdrawing 8% per year from a £200,000 pension could see their pot exhausted by their mid-80s. This assumes investment growth of 5% a year, and annual fees of 1%. Find out more about drawdown in our article How pension drawdown works.
Which is most popular, annuities or drawdown?
The number of people choosing to buy an annuity, or guaranteed income for life, with some or all of their pension savings jumped by 39% last year, from 59,163 in 2022/23 to 82,061 in 2023/24, according to the Financial Conduct Authority’s latest Retirement Income Data, with many seeking the security of regular payments in these uncertain times.
When interest rates are higher, as they are now, annuities tend to become more popular, as annuity rates tend to rise when interest rates go up. However, we are expecting further interest rate cuts in the coming months and when this happens, we could see annuity rates start to fall. According to Hargreaves Lansdown, a 65-year-old with a £100,000 pension can currently get up to £7,146 per year from a single life level annuity. This is up around 43% on what they would have got just three years ago.
Rob Hillock, Senior Manager in the Personal Financial Planning team at independent consultancy Broadstone, said: “The increase in annuity rates has fed through into a significant rise in sales through 2023/24 as pension savers rush for security and to lock in elevated rates. Given annuities offer peace of mind that retirees’ money will not run out during retirement it is perhaps unsurprising that more attractive rates have led to a surge of popularity.”
However, despite annuities seeing a jump in popularity, sales of drawdown were also up last year, increasing by 28% from 218,183 in 2022/23 to 278,977 in 2023/24. This means drawdown is still the preferred option for the vast majority of those accessing their pension savings.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown said; “Income drawdown has also remained hugely popular, with people taking full advantage of the flexibility on offer, but again there is a note of caution.
“Over 225,000 pots had an annual withdrawal rate of over 8%. There could be times during retirement when you need to take a bit more from your income to cover big expenses such as holidays, but doing it on a sustained basis can lead you to erode your savings pretty quickly and leave you in trouble later on. As a rule of thumb, withdrawals from a drawdown pot should be around 4% per year or in line with the natural yield on investments to remain sustainable long-term.”
Taking a mix and match approach
There’s no rule to say that you can’t have both an annuity and use drawdown if you want to, so you may decide that you’d like to go for a mix and match approach. Say, for example, that you needed £14,000 a year to cover the basics in retirement, you could put your State Pension towards this and buy an annuity to cover any shortfall. You could then leave anything you have left over in your pension fund to dip in and out of as you need it using drawdown.
You can learn more about the choices available to you in our guide What are your pension options at retirement?
Where to go for help
What’s best for you financially may not be right for someone else. So don’t feel you have to do certain things just because someone you know has.
First of all, you don’t have to do anything just because you’ve retired. In reality, it’s likely you’ll need the money, but if you don’t, you can leave it where it is. It will continue to grow tax free. It is worth checking what it’s invested in, though, to make sure you’re not taking on too much risk.
It’s worth talking through your options with the government’s free service, Pension Wise, run by the Pensions Advisory Service and Citizens Advice, which provides people aged 50 and above with free guidance on their pension choices at retirement. You can give them a call on 0800 138 3944 to book a free appointment, or you can book one via their website.
You can’t get financial advice from Pension Wise (because they’re not regulated as financial advisors), but you can get some pointers about what you need to think about and, best of all, it’s free.
If you want personal recommendations, you’ll need to talk to a financial advisor. Financial advice isn’t generally cheap but it really can be money well spent. Learn more about this in our guide How financial advice could boost the value of your pension by £47k.
Bear in mind that you may be able to take £500 from your retirement savings tax-free to help pay for advice. You can find out more about this in our article What is the Pensions Advice Allowance? Don’t go with an advisor you don’t feel comfortable with and don’t go with anyone who doesn’t answer your questions in a way that you can understand.
If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 1,500 reviews on VouchedFor, the review site for financial advisors.
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