February 2023

Pension drawdown vs annuity: which could best suit you this year?


Ever since Pension Freedoms legislation was introduced in 2015, UK residents have had greater control over how they can access their pensions. Once you reach the normal minimum pension age of 55 (rising to 57 in 2028), you’ll have a range of choices as how to best access your retirement funds.

Among the options available, two of the most popular methods of pension withdrawal are annuities and drawdown. Annuities supply you with a guaranteed income, while pension drawdown gives you greater flexibility and control over your retirement savings in exchange for more responsibility. 

Before you can decide which pension withdrawal method best suits you, you should ideally review your financial situation. Read on to discover the differences between annuities and pension drawdown so you can decide which could best suit your financial needs in 2023. 

Drawdown allows you to take some of your pension, then leave the rest invested

Pension drawdown, sometimes referred to as “flexi-access drawdown”, allows you to take a 25% tax-free lump sum from your pension pot. Then, the remainder of your retirement savings can be reinvested, with the goal of growing them even further. 

You can draw as much, or as little, as you like. It’s worth remembering that you can only take the first 25% tax-free; the rest of your withdrawals will typically be subject to tax. 

Flexibility is one of the key features of pension drawdown – you have control over how much of your pension pot you draw, how much is left invested, and even when you want to take your pension.

Also, any unspent retirement savings held in your pension are typically passed on to your beneficiaries when you die. 

Though, this control comes with additional responsibility, as going into drawdown comes with no guarantee that you’ll have sufficient funds for your twilight years. So, if you draw too much money, or your investments drop significantly in value, you could end up running out of money during retirement.

An annuity is an insurance product that provides you with a guaranteed income

Meanwhile, an annuity is an insurance product that pays you a guaranteed income for the rest of your life. 

In exchange for all, or part of, your pension pot, your pension provider or a separate insurance company will provide you with a guaranteed income, typically either monthly, quarterly, half-yearly, or annually. Annuity rates will vary between providers, so it’s often sensible to shop around and find the most suitable option for you.

When you purchase an annuity, the provider will decide how much to pay you based on the size of the pension funds you have as well as factors such as your age, health, and lifestyle. 

An annuity could be a useful retirement option for those who are worried about having to rely on investments to support them during retirement, especially during times of market uncertainty. 

Purchasing an annuity is irreversible, and it usually can’t be passed on to your beneficiaries when you die. Though, since some annuity products include a spouse’s income, a beneficiary could continue receiving payments in this case.

You have several different options when it comes to annuity products. This includes:

  • Lifetime annuity, guaranteeing you a retirement income for the rest of your life. The income you receive from a lifetime annuity is based on your health and age at the time of purchase, and some even make payments to your beneficiaries when you die.
  • Enhanced annuity, designed for those with health conditions. Typically, you receive less money from financial products when you’re in poor health, so enhanced annuities provide you with extra income to cover any later-life care you may need. 
  • Fixed-term annuity, paying you an income over a set period of time. These terms tend to be 20 to 30 years, and since it could expire while you’re still alive, your age and health typically don’t affect the value of your payments. 

Each payment you receive from an annuity is recorded as a return on the capital you initially invested, alongside interest. While you do typically pay tax on the interest from your annuity income, you won’t be asked to pay Income Tax on the capital.

Which of the two would best suit you in 2023? 

Both annuities and pension drawdown offer interesting ways to access your funds, so when it comes to deciding which of the two could better suit you in 2023, you should ideally review your financial situation and likely needs during retirement. 

Annuities offer a guaranteed income, either for the rest of your life or for a set period of time. This can give you peace of mind that you’re not going to run out of money during retirement, and that a sudden market downturn won’t impact your retirement income.

While annuity rates have been lower over the past few years, 2022 was a good year for the pension products. In fact, in a previous article, we discussed how annuity rates reached a 14-year high in 2022.  

However, it’s worth noting that while you are guaranteed an income with an annuity, this comes at the cost of flexibility, as you can’t control the level of income you take, or even when you receive the payments.

Meanwhile, even though pension drawdown is affected by the performance of your investments and can even see you run out of money if you’re not careful, you’re given more control over how and when you draw your pension.

It may be worth considering both an annuity and drawdown in 2023. The annuity could cover your fixed expenses, then you could use drawdown to cover any non-essential costs, such as travel or home renovations.

In this case, drawdown will provide you with a short-term income for any luxury spends, meaning your lifestyle during retirement is less likely to be affected by short-term market volatility. 

Of course, potentially the best way to decide whether pension drawdown or an annuity would best suit you this year is to speak with a financial adviser. 

Together, you can closely review your financial situation to ensure you have enough money to fund the life you’ve always dreamed of during retirement.

Get in touch

Both pension drawdown and annuities come with their own sets of benefits, which can make it tricky to decide which to choose. At Holborn Financial, we can help you figure out which would best suit you this year. 

Please email info@holbornfinancial.com or call 020 8946 8186 to get in touch.

Please note

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.