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Annuity vs Drawdown – Which is the right choice for you?

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Introduction

In terms of retirement income options, drawdown has been a much more popular option over the last 15 years or so since the financial crisis. However, given higher interest and gilt rates over the last couple of years, interest in annuities has risen.

Which option is right for you (or if a combination works for you) will come down to your personal and financial circumstances. We will go into further depth on the nuances of the options below, but Tideway Wealth can assist you in deciding upon the best option for you given your objectives.

Understanding Annuities

A pension annuity will pay you a regular, guaranteed income for the rest of your life. You exchange part or all your pension pot and in return, the insurance company will give you an income for the rest of your life, no matter how long you live for.

There are various types of annuities that you can take out and the annuity rate you will get will depend on the option chosen – generally, the more options you choose, the less attractive a choice you can get:

Types of Annuities

  • Single – the annuity will pay an income until you die
  • Joint-life – the annuity will continue to pay out to your spouse after your death until their death.
  • Inflation-linked or fixed rate – you can pick an annuity to increase by CPI/RPI or in fact a chosen fixed rate.
  • Lifetime or fixed-term – an annuity will usually pay out for the remainder of your life, but you can choose one for a fixed-term (e.g. 5, 10 years etc.)
  • Enhanced annuity – you can qualify for a higher annuity rate if you have health or lifestyle issues that could impact your life expectancy.
  • Deferred annuity – you can choose an annuity to start later (for example, if you’ll pay Income Tax at a lower rate in the future).
As with every pension product, there are advantages and disadvantages of taking out an annuity, some of which are below:

Benefits:

  • You receive guaranteed income which gives you peace of mind.
  • You can select it to be joint life, which means your spouse will continue to receive the income in the event of your death.
  • You can select an increasing annuity which will preserve the purchasing power of the income.
  • Annuities carry less risk than keeping your pension invested.
  • There are no ongoing costs.

Drawbacks:

  • The decision is irreversible once made.
  • You could pay Income Tax on the income for the rest of your lifetime.
  • The income forms part of your estate for Inheritance Tax purposes if you do not spend all of it.
  • There is no flexibility if you wish to alter your retirement income level.
  • You will not benefit from investment growth.
  • You cannot pass on any pension assets to your chosen beneficiaries after death.

Understanding Pension Drawdown

Leaving your pension into drawdown means that you have complete flexibility over whether or how much income you can withdraw from the pot. The trade-off, however, is that the assets will be subject to investment growth and therefore, the value of your pension could rise or fall.

The benefits and drawbacks of a pension drawdown strategy are as follows:

Benefits:

  • You have complete flexibility in terms of withdrawing or altering your income.
  • You can continue to benefit from investment growth.
  • The assets remain in the pension wrapper and can grow tax-free.
  • You can choose how you want to take your tax-free cash.
  • The pension remains outside of your estate for Inheritance Tax purposes.
  • You can pass on any unused pension to future generations.

Drawbacks:

  • You are exposed to investment risk and the value may go down as well as up.
  • There will be ongoing product and investment costs.
  • You may need to factor in ongoing advice costs.
  • You are exposed to longevity risk – you may live longer than expected and risk depletion of the pension.
  • If not managed well, you could be liable to Income Tax.

Comparing Annuities Vs Drawdown

To summarise the key features outlined above, the main differences between annuities and drawdown boil down to:
The benefits and drawbacks of a pension drawdown strategy are as follows:
FeatureAnnuitiesDrawdown
Financial security
  • An annuity will be payable for your lifetime once taken out, with no exceptions
  • Whether or not a drawdown fund lasts depends on the underlying investments, your withdrawals and your longevity
Flexibility
  • Once you take out an annuity, it is irreversible, and you will receive the income for the rest of your life
  • You can alter the levels of withdrawal depending on your circumstances
Income Tax
  • You are potentially committing to paying Income Tax for the remainder of yours (and your spouse’s) lifetime
  • With professional help, you can manage the tax liabilities and change the level of income to ensure you pay minimal tax
Inheritance Tax (IHT)
  • Income from an annuity will form part of your estate and thus be liable to IHT
  • The drawdown pension fund remains outside of your estate and thus won’t be liable to IHT
Passing on assets
  • The annuity will end with yours or your spouse’s death
  • You can pass on any unused drawdown funds to future generations
Investment growth
  • The annuity will not benefit from investment growth
  • The drawdown fund remains invested, so will continue to benefit from growth

Which option is right for you?

There is no right answer here and a lot will depend on your personal and financial circumstances. Some of the factors to consider are:

  • Age of you and your spouse
  • Whether either/both of you have any medical conditions
  • Value of your pensions
  • The value of your other assets
  • How comfortable you feel with being invested
  • Whether you wish to pass on any assets to your children/other relatives

Planning for retirement is one of the most important processes you’ll undertake in your lifetime. Doing it correctly will help you enjoy your later years and ensure that your money is used to its fullest potential, securing both your future and your family’s financial future.

If you are in any doubt, then please do get in touch with Tideway Wealth – we will be happy to sit down with you to discuss which options could work well for you and what factors you need to consider to give you peace of mind that you have made the right decision.

Risk Warnings

  • The content of this document is for information purposes only and should not be construed as financial advice.
  • Any rates of return used are for illustrative purposes only. Please be aware that the value of investments, and the income you may receive from them, cannot be guaranteed and may fall as well as rise.
  • Any rates of tax referred to are correct as at the date of this document and may be subject to change in the future.

For more information about retirement planning visit our Tideway Dual Account page

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