Annuity vs drawdown - what are the differences?

When you retire, you normally have the freedom to choose how you take money out of your personal pension. You can take your entire pension in one go if you want. But for those who desire a regular income, the main options are an annuity or drawdown.

This article is to help you understand the difference between Annuities vs Drawdown, but it isn't personal advice. Both options have pros and cons, so it's important you fully understand how each one works before you take money from your pension.

If you're not sure what's the best option for you, get guidance from Pension Wise, or ask for financial advice. If you choose to invest, the value of your investment will rise and fall, so you could get back less than you put in. All the information and figures in this article are correct as at 24 July 2024. Tax rules can change, and their benefits depend on your personal circumstances. A pension is meant for your retirement, so you can't normally access your money until you're 55 (57 from 2028).

Below we take a look at how annuities and drawdown compare:

Discover your retirement options

Both options have pros and cons, so it's important you fully understand how each one works before you take money from your pension.

How annuities work

Annuities offer a guaranteed income for the rest of your life. It doesn't matter how long you live, or what happens in the stock market. When using the money in your pension to buy an annuity, you can usually choose to have up to a quarter (25%) of the amount paid to you as a tax-free cash lump sum, and use the rest to buy the annuity. The annuity income you receive is taxed as earned income.

The amount of income you could get will depend on factors including your health and lifestyle. These could mean you qualify for a higher income, but must be declared at the start. Even if you confirm minor details like your height, weight, or how much you drink or smoke.

You can normally choose for your income to increase each year, either by a fixed percentage (normally 3% or 5%), or by linking it to inflation (the Retail Prices Index (RPI)). Choosing one of these options means your starting income will usually be lower, but it will be better protected against inflation.

Annuity rates are closely tied to interest rates. When interest rates are high, so are annuity rates. And vice versa when they drop.

With interest rates at a 16 year high, a 65-year-old with a £100,000 pension can get 55% more annuity income, than someone the same age three years ago.

At the time of writing they could get up to £7,217* each year from a single life level annuity with a five-year guarantee.

In July 2020, when interest rates were as low as 0.1%, someone in the same position would have only received £4,670*.

Source: HL annuity index correct 11 July 2024. The income you could receive will depend on your circumstances. Quotes are only guaranteed for a limited time and rates change frequently so they could go up or down in the future.

When is the right time to buy an annuity?

Even though rates have risen, the right time to buy an annuity really depends on your circumstances. A good time to consider buying an annuity might be when you give up work completely - remember you usually only access a pension like this from 55 (57 from 2028). You'll no longer have a steady income stream from earnings to cover your essential bills. An annuity can help plug this gap.

Although an annuity offers a secure income for life, they lack flexibility. If your circumstances change, you are locked into an annuity rate, and it cannot be changed. This is one of the main reasons people consider drawdown or a mix of both.

Find out how much annuity income you can receive

How drawdown works

You can move your entire pension into drawdown in one go. Or you can move a portion in at a time (this is known as phased drawdown). You can normally take up to 25% as tax-free cash, and the rest remains invested. This means that you could receive a growing income if investments perform well. But if your investments don't perform as well as you might hope, your income could reduce.

You decide how much income to take (which is taxable), and when to take it. If you take too much out, live longer than expected or your investments don't perform well, your pension fund could run out completely or the income you can withdraw could fall.

You can apply for drawdown with your current pension provider (if they offer it) or transfer your pension to a drawdown provider like HL. Our pension drawdown calculator could help you understand how long your drawdown plan might last.

Before transferring, check that you won't lose any valuable benefits or need to pay high exit fees.

Why choose drawdown with HL?

Learn more about drawdown with HL

How to get the best of both worlds

Investors could consider a mix and match strategy to make the most of both options and their benefits. For example, part of your pension could be used to secure an annuity which covers your essential bills and living costs. Then you could move the rest of your pension into drawdown to provide a flexible (and hopefully growing) income as and when you need it.

Are you ready for your retirement?

Retirement is an important financial milestone. It's likely to be something you'll only do once, and the decisions you make could impact the money you'll get. So, if you're not sure what to do with your pension or where to invest, take personal advice or seek guidance.

We have a team of experts who are here to help you make the most of your pensions. So if you want to know more about HL's retirement service, you could book a call back at a time that suits you. The experts on our Pensions Helpdesk won't give personal advice but can answer any questions you may have.

Our UK-based helpdesk is also here for you six days a week to help (Monday to Friday 8am-5pm and Saturday 9:30am-12:30pm). You can call them on 0117 980 9926.

If you think you would like personal advice, you can find out more within the retirement advice section of our website. You'll only pay for the advice you need.