Annuities vs pension drawdown: which option is right for you?

It’s been nearly a decade since pension freedoms changed the way we can access our retirement savings.

Before then, swapping your savings for a guaranteed income in the form of an annuity was the default option. 

But today, pension drawdown is a more popular way for retirees to access their money.

So how do the two options compare, and how do you decide which to choose? Here we weigh up the pros and cons of each. 

How retirees are using their freedoms

The changes introduced in 2015 placed greater responsibility on savers to make decisions about what to do with the money in their defined contribution pensions.

With these pensions – the most common type of private pension – the scheme provider invests your money, and the final value of your pot depends on how much you (and your employer, if it's a workplace scheme) have contributed, and how the underlying investments have performed. 

You have to be at least 55 to access your pension savings.

Recent data from the Financial Conduct Authority (FCA) shows that pension drawdown continues to be a very popular way for retirees to access their money. Nearly 280,000 savers chose it in the 2023-24 tax year – an increase of 28% on the previous year. 

Meanwhile, sales of annuities rose by 39% to 82,061, their highest level for nearly 10 years. This was driven by an increase in the rates offered by annuity providers. 

How do annuities work?

An annuity allows you to swap your pension savings for a guaranteed regular income that will last for the rest of your life.

How much you get is determined by the value of savings you want to exchange, your health and the rate the annuity provider offers. 

The certainty that annuities offer is their main selling point, but this is at the expense of flexibility:

Pros

• Payments are guaranteed for your lifetime.
• No investment risk involved.
• You have the option to increase payments each year in line with inflation (but this can be expensive).
• No ongoing charges to pay.

Cons

• Once you've arranged an annuity, you can’t alter your level of income or switch to another provider.
• You can't pass on income from an annuity after your death unless you arrange this from the outset – for example, by choosing a joint-life annuity.
• After you swap your savings for an annuity, this money is no longer invested and so will no longer have the opportunity to grow.

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How does pension drawdown work?

Pension drawdown involves keeping your savings invested when you reach retirement. You can then take money out as you wish. 

Flexibility is the big selling point, as drawdown allows you to tailor your income to match your circumstances. But it also comes with risks.

Pros

• Your money can continue to grow, as it'll remain invested.
• You can alter how much you withdraw, depending on circumstances.
• You can pass on any remaining money to loved ones after you die.

Cons

• It's up to you to manage your investments and withdrawals carefully to ensure your pot lasts for the rest of your life. Take out too much, too soon and you could run out of money.
• The value of your pot could take a hit if your investments underperform.
• You’ll have to pay charges on the investments you hold, as well as those levied by your drawdown provider.

Can I combine an annuity with pension drawdown?

Yes, you can take a mix-and-match approach when converting your retirement savings into income. It’s not a binary choice. 

For example, you might decide to start off with drawdown, and then buy an annuity later in retirement. 

You'll generally find that the older you are when you arrange an annuity, the higher the annuity rate you'll get, reflecting the fact that the annuity provider won't have to pay out for as long. 

Recent data from Hargreaves Lansdown shows that a 65-year-old with a £100,000 pot can get up to £7,144 a year from a single-life, level annuity with a five-year guarantee. A 70-year-old could get up to £7,885, while for a 75-year-old this would rise to over £9,100 per year. 

Where to get help with retirement decisions

If you’re considering drawdown but are not an experienced investor, the best way to ensure your money is invested appropriately for you and that your withdrawals are sustainable is to enlist the help of a regulated independent financial adviser.

But just 31% of those who accessed their pension for the first time in 2023-24 took regulated advice (down from 33% in 2022-23).

The costs involved mean this isn’t an option for everyone, but you can access free guidance from Pension Wise. This service, from government-backed Moneyhelper, offers face-to-face, telephone or online appointments to over-50s who have a defined contribution pension. 

The session covers your options for accessing your pension, what tax you could pay and how to spot a possible scam.

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