Understanding your pension options: drawdown, annuities, or a blend

Last Updated: 1 March 2024

We often find this to be one of the most important decisions faced by retirees. We, therefore, spend lots of time carefully exploring options together, agreeing on the best way forward for an exciting and secure retirement. This article lays out some options that we cover with our clients.

The most common ways to withdraw an income from your pension are drawdown, annuities, or a blend of the two.

Let’s take a snapshot view of the benefits and risks for both:

What is drawdown?

Income drawdown is a way to access your pension savings while keeping your funds invested.

Income drawdown allows you to take money directly from your pension as and when you need it. When you withdraw cash, up to a quarter is tax-free, while the rest is subject to income tax.

Benefits of drawdown

It’s an increasingly popular choice for retirees due to the flexibility it offers. You can choose how much income you withdraw, giving you control over your finances in retirement. If you don’t need any income, you can keep your pension invested, providing the opportunity for your funds to grow, potentially increasing your retirement income over time.

You can tailor your withdrawals to suit your tax position. For example, you may take some tax-free cash from the pension, taxable income, or a combination of both.

Any remaining funds in your pension can be passed on to your beneficiaries when you die. If you die before age 75, your pension is usually passed on tax-fee; death after 75 means your beneficiaries will probably pay Income Tax on any withdrawals.

Your pensions are generally outside your estate, so they are not subject to inheritance tax either.

Drawdown gives you the most flexibility and can be tax efficient. Any withdrawals from your pension pot are only taxed if they exceed your Personal Allowance, and, in most circumstances, anything left after you die is not liable for Inheritance Tax.

Risks of drawdown

The pension is not guaranteed to last for the rest of your life. If the investments don’t perform as well as you expect or if you take too much income, the pension could run out. As financial planners, we address these critical challenges with clients using our experience and sophisticated forecasting software to help mitigate these risks.

If you take too much out, you may have a large Income Tax bill, and flexibility comes with complexity. You may be savvy enough to manage this all yourself; otherwise, you can hire a qualified financial planner to help.

Annuities:

What is an annuity?

An annuity is a contract you buy from an insurance company using your pension savings. You swap your pension for a regular income which lasts for the rest of your life or a set period.

The amount of income you’ll get depends on many factors, including the value of your pension, your health and lifestyle, your current/previous job, and where you live(!).

Annuities can provide financial security and peace of mind in retirement because you know exactly how much income you’ll receive, regardless of how long you live.

Benefits of an annuity

Annuities provide the security with a steady, guaranteed lifetime income. This can help you plan and alleviate concerns about your pension pot running low if you live longer than expected. Your annuity will not be impacted by any fluctuations in investments or other market factors, alleviating another potential source of worry.

You can have the income increase each year (or remain at the same level). If you choose to keep the income level, then you must be aware of the impact inflation will have on this income. Something that costs £1 today may cost £5 later in retirement, so your income needs may increase. By linking the annuity to inflation, you can mitigate this risk, but it does come at a higher cost, so you may begin with a lower initial income that increases over time.

Risks with an annuity

Once you buy an annuity, you typically can’t change or access the money you used to purchase it. This lack of flexibility means you may be unable to respond to unexpected expenses or changes in your financial situation.

When you die, the annuity stops, so if you die soon after taking out the annuity, you won’t benefit from the full amount of your pension savings. You can add a spouse’s annuity option and a ‘guarantee period’ – where your income will be paid for a minimum period, even if you die. Both these options usually provide a lower initial income.

Unless you choose an inflation-linked annuity (which typically provides a lower initial income), the purchasing power of your annuity income may decrease over time as prices rise.

Annuities can be complex financial products with various options and features. Understanding the terms and conditions, including any fees or penalties, is essential to make an informed decision. Discussing your options with a qualified financial planner is usually sensible to agree on the best annuity for you.

Blended option – drawdown and annuities

A mix of the two options may be the perfect fit for you. Using some of your pension on a drawdown basis will give you freedom and flexibility and, if you combine it with an annuity, you can enjoy the security of a regular income too. Depending on your circumstances and goals, this could be the best of both worlds.

We hope you found this helpful snapshot, but it’s important to note that this process is complex. None of the information above constitutes advice; the right course of action for you depends on your personal circumstances.

Decisions around your pension will need the guidance of your financial planner, and whenever you’re ready, we’re here to help with our expert pension advice in Cirencester.

Investment risk information

Please note, the value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

This information is for general information only and does not constitute advice. The information is aimed at retail clients only.

Past performance is not necessarily a guide to future performance.

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Independent financial adviser Cirencester, financial advice for business owners and company directors in Cirencester

Abode Financial Advisers is an Independent Financial Adviser in Cirencester.

Abode Financial Advisers is a financial adviser based in Cirencester, Gloucestershire. Abode Financial Planning is an independent financial advice firm offering comprehensive financial planning services, including: independent financial advice, retirement planning, pension advice, investment advice, wealth management, and inheritance tax planning.

If you wish to discuss your situation, contact us for a no-obligation initial call, held at our expense. Call us on 01285 703 060.

Abode Financial Advisers is located at Watermoor Point, Watermoor Road, Cirencester, Gloucestershire, GL7 1LF.