Annuity or Drawdown?

When you retire, if you have a defined benefit pension (usually only from a Government body these days) you are given the option to take a tax free lump sum, which of course reduces your ongoing income, but otherwise you are simply told how much you will be ‘paid.’

However your defined contribution pension providers will write to you and ask you how you want to take your pension.

You can choose from the flexi-access drawdown options, or to buy an annuity.

An annuity is an insurance policy, ultimately 100% protected by the Government, that agrees to pay you a monthly income like a defined benefit pension.

With an annuity you have various options:

1. Lifetime income
2. Fixed term income (for example if you retire early and have a shortfall until other pensions start in a few years)
3. Indexed income, which increases over time to counter inflation

The combination of these that you pick determines the price you pay - for example a lifetime annuity that increases its payments to counter inflation will be the most expensive for people in good health with a normal life expectancy.

But people with poor health should declare all their issues, as this will reduce the cost of the annuity.

An annuity once purchased, cannot be changed or reversed so you lump sum is gone, and no one will inherit it even if you die early.

With ‘flexi-access drawdown’ you can choose:

1. Leave the pension invested
2. Take regular payments with 25% tax free each time
3. Take up to 25% tax free as a lump sum then invest the rest
   1. And take occasional income
   2. Or regular income

The money remains yours and you can leave it to whoever you wish in your estate.

So which is better for you?

The only way to know which of these options is best for you is to go through these steps:

1. How much income do you need to cover your essential living costs?
   1. Increase this by inflation up to at least your 90th birthday
2. What guaranteed income do you have?
   1. Is there a shortfall? If not then you can look more at the drawdown option as it gives you flexibility to withdraw and invest money depending on your goals
   2. If there is a shortfall, you need to obtain some annuity quotes and compare these to an investment projection that is based on your risk profile. Then you can decide which is most likely to suit you. If the two projections are similar you should take the guaranteed annuity. If the investment is likely to outperform the annuity significantly you should seek advice on how to safely protect your income while investing.