Annuity or Drawdown?

Pensions freedoms have given retirees more choices about their finances but this can leave many wondering which is the right path to choose.

Transitioning from working life to retirement can be an emotionally tricky period. Often much of a person’s identity is built around their career and the relationships they have built over many years in work.

If that wasn’t enough, those entering life after work also need to make some significant decisions about their retirement finances; just how will they afford the next stage in their life and what financial options do they even have at their disposal.

Creating a financial plan for later life is not a simple task, with the Pension Freedoms act (introduced in 2015) meaning individuals gaining access to their pension savings now have a variety of financial products to choose from – instead of just deciding which provider to buy an annuity from.

Knowing which of these options is best suited to their needs can take time to understand, as it comes down entirely to their individual circumstances; how much they have saved, the amount of retirement income they need, and how their requirements may shift as they progress through later life.

In recent years, many people entering retirement have chosen to use an income drawdown plan rather than purchasing an annuity. These plans can provide flexible access to savings as retirees can withdraw their money in smaller amounts over time, benefiting from additional interest build up on the amount which remains saved.

They are available to anyone aged 55 or over with a Defined Contribution (DC), or Self Investment Personal Pension (SIPP), pot. The major advantage of these plans relates to the increased flexibility that savers have.

While they may still want to withdraw the 25% tax free sum that the government allows all savers reaching retirement age, they can still continue to grow the value of the remaining 75% of their savings. That is because the remaining portion will still be invested and continue attracting returns.

Of course, drawdown plans are not risk free. That is because the part of the pot that continues to be invested could still decrease in value if the fund performs badly. This is an important consideration for people with a low-risk appetite.

Annuities have long-been a cornerstone of the UK pension system and provide retirees with a guaranteed income for life. This ensures complete certainty over retirement income and can be a good option for people that are less confident about keeping their savings invested in a fund.

Since the introduction of Pension Freedoms, the availability and price competitiveness of annuity plans has improved, however, many still feel they offer comparatively poor returns when compared with drawdown options.

When it comes to choosing an annuity, retirees need to remember that they could potentially access better returns depending on their health. Providers are making an assumption about how long a person is likely to live for, so customers can access better rates if they have previous or ongoing medical issues.

Smokers, for instance, are likely to benefit from an improved rate because their life expectancy is reduced. Health issues such as high blood pressure and obesity can also positively affect the rate a person receives. Always be sure to declare conditions like these are they will positively impact the income received.

Fixed term annuities can also provide more flexibility to those wanting a secured income but that do not wish to cash in the whole value of their pot. With this, an annuity income is paid for a fixed period – usually around five to ten years. These plans have become popular over the pandemic with a 33% in fixed rate annuities in the second quarter of 2020 as more people have sought extra income security.

Annuities and drawdown plans need not be mutually exclusive. Many people entering retirement these days are likely to have several pension pots and they can aggregate or move their money as needed. This could mean using one pot to purchase an annuity, while leaving another invested in a fund to benefit from additional growth.

Creating a hybrid plan, which capitalizes on the benefits of each product type, can be a good option for those wanting to diversify their retirement income streams.