Accounts | Chartered Accountants

12/12/2018

Annuity vs drawdown: choosing between them is one of life’s biggest financial decisions. After all, you want your pension to work as hard as possible for your financial future. And after decades at the coalface, you deserve the fiscal freedom to enjoy yourself. Here are the key points to consider when weighing up annuity vs drawdown.

Financial security

It’s hard to argue with the security that annuity provides. In essence you trade your pension pot for the privilege of having a guaranteed income for life. With an annuity you can bank on the same annual income – year after year – no matter how far you journey into your twilight years.

With drawdown your fund is finite. You rely on the pension pot you have amassed to sustain your retirement years. And you must take responsibility for managing your own wealth (although you can always seek independent wealth management advice). And therein lies the challenge.

Without a crystal ball it’s difficult to calculate how much money you need for retirement. That makes it crucial to pace yourself with drawdown. 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.

Flexibility and convenience

Having worked hard to build your pension pot, it can be galling to relinquish your right to manage your own retirement provisions. No such problem with drawdown. Each year you can withdraw as much money from your pot as you wish (though some scheme providers impose maximum limits). So if you want to bank £20,000 one year and then £12,500 the next, that’s not a problem. You are free to either spend this money or reinvest elsewhere. It’s yours, after all. You are in control.

Of course the freedom and flexibility offered by drawdown must be balanced against the risk of running your pot dry. It’s also worth noting that annuity funds aren’t completely rigid and inflexible. For instance you can opt for an escalating annuity, which rises each year to combat inflation and maintains the value of your income, or an investment-linked annuity where the level of income varies with investment performance.

Maximising your income

Making your money go as far as possible is one of the secrets of accumulating wealth. If your fund is well invested in markets that perform strongly, drawdown is far more likely to give you a larger annual income than your comparative annuity payment. It all depends how much risk you are prepared to take with your pension pot. But in terms of potential, drawdown trumps annuity.

Get a tax-free lump sum

A cruise in the Caribbean? Something sporty for the driveway? A few upgrades to your abode? If you feel like treating yourself when you finally retire, both drawdown and annuity funds allow you to take up to 25% from your pension pot as a tax-free lump sum. Yours to do with as you please.

Of course, just because you can withdraw a tax-free lump sum doesn’t mean you should. The more you leave in your pot, the more potential it has to grow and generate larger annual annuity payments.

What about the leftovers?

The older you get, the more people tend to think about the long-term welfare of their nearest and dearest. Yet there’s a clear rule with annuity: it dies when you do. The only exception is if you have joint annuity with a spouse (which results in far lower annual income) or if you select an annuity fund with value protection, which can be expensive.

In short this means that if you die prematurely, you may have wasted the pension pot you worked so hard to accumulate. And that value cannot be passed on to your beneficiaries. With drawdown, however, the entire remaining value of your pot can be passed on, subject to tax charges that may apply…

Annuity vs drawdown: so which is better?

The truth is that determining whether annuity or drawdown is best depends entirely on your personal circumstances. There are benefits and drawbacks to both. And what’s best for one person isn’t necessarily going to be best for you.

Annuity vs drawdown: the best of both worlds?

If only you could blend the best bits of annuity with the best bits of drawdown. Well perhaps you can. There are hybrid products on the market that provide a combination of guaranteed lifetime income with an element of drawdown flexibility. However be sure to study these products carefully as they can be expensive.

Alternatively you could begin with a drawdown fund and switch to annuity later, or purchase an annuity with some of your fund, rather than all of it. That’s a particularly attractive option if you continue to work part-time during the early years of your retirement, or if you have alternative sources of income from other investments.

Good advice is invaluable

Planning your retirement income involves some of the biggest financial decisions you will ever make. The stakes are high – you are essentially gambling with your future financial security. That’s why the government recommends seeking the advice of an expert in retirement planning or wealth management. And we can help with both, with advice that is clear and easy to understand.

Here at Prydis we have a proven track record of helping hundreds of clients make smart decisions about their financial future. Not only can we talk through your personal circumstances to build a financial strategy that reflects your world. As an independent financial adviser we also have access to the entire pensions market and can help you find the funds that make sense for your circumstances.

Sound good? It’s free to call for an initial consultation. Try us.