Annuity or pension drawdown?

This content was reviewed and approved by Tamlin Russell.

Any references to tax-free or tax treatment are based on our understanding of current legislation and tax treatment at the time of writing, which may of course change in the future.

The information on this page should not be considered as financial advice. If you are unsure what’s right for you, please make sure you speak to a financial adviser.

Choosing an annuity or pension drawdown is one of the biggest financial decisions you’re ever likely to make. Annuities and pension drawdown are the two main options when converting a pension pot into retirement income.

While an annuity pays you a guaranteed, regular income during your later years, drawdown is more flexible. It allows you to keep your pension invested and take payments on an ad-hoc basis.

Understanding the difference between an annuity and pension drawdown is key to putting your retirement finances on the strongest possible footing. Read on to explore the potential advantages and disadvantages of each – and which might be best for your circumstances.

Annuity vs drawdown: What's the difference?

Annuities and drawdown are both products that help retirees turn the private pension savings they’ve built up over their career into a manageable income. Their main difference between an annuity and a pension drawdown revolves around how this income is paid.

How does an annuity work? 

Buying an annuity effectively allows you to trade in your pension pot for a regular income in retirement. The aim is to provide you with guaranteed payments at regular intervals to stop you running out of cash.

Annuities are mainly an option for defined contribution scheme members. They can last for:

• The rest of your life - Products known as lifetime annuities offer peace of mind by making payments until you pass away.

• A specific period - Fixed-term annuities give you the opportunity to receive payments for as little as one year, or multiple decades.

When you set up an annuity, you’ll know exactly how much money you’re getting and for how long.

What are the advantages of buying an annuity?

Buying an annuity provides guaranteed, stable income for life or for a set period. Annuities can give you financial security regardless of market conditions, and can protect against outliving your savings by converting your money into long-term payments.

Annuities offer a range of potential benefits, including:

• A guaranteed amount - With guaranteed payments for the rest of your life or an agreed period, you won’t need to worry about economic disruption or stock market swings. This is a major difference between an annuity and pension drawdown.

• Tailored options - ‘Level’ annuity products are designed to pay you a fixed amount, while ‘escalating’ annuities increase payments as the years roll on. If you face a shorter life expectancy due to underlying medical conditions, an enhanced annuity might offer larger payments.

• A regulated income - No one knows exactly how long their retirement will last. Annuities can stop you running short of money as the years pass.

• Limited management - Annuities can take the strain out of money management, with your pension provider or insurance firm monitoring payments for you.

If you want to find out what your pension income could be, try our annuity calculator.

What to be careful of with annuities

On the flipside, annuities won’t be right for everyone. Some of the potential drawbacks of a pension annuity include:

• Inheritance uncertainty - Unless death benefits are added, an annuity can’t be inherited by your loved ones after you die. However, you can choose a product that continues to pay an income or lump sum for your beneficiaries when you pass away.

• Little room for manoeuvre - Your income is inflexible because your annuity terms and income are decided when you purchase a product, making it hard to change your mind further down the line. However, you can choose an annuity that increases in value over time.

• Lack of growth potential -An annuity, unlike pension drawdown, doesn’t require you to invest any money. While that can shield you from market turbulence, it also means your income is limited by the annuity rates on offers which may prevent you from enjoying investment growth.

• You're locked in - Once you’ve bought a pension annuity, you can’t usually change your mind or cash it in.

How does pension drawdown work?

Pension drawdown, also known as income drawdown, offers a more flexible approach to retirement than an annuity. Instead of exchanging your retirement savings for a regular, guaranteed income, your pension pot can stay invested in the stock market.

You can access as much or as little of your money as you like, and withdrawals are taxed as income. You’ll benefit from any investment growth and gain more freedom over when you draw an income from your pot. You can opt for regular payments or take money as and when it’s required.

If you die, any unspent money can be passed on to your loved ones and beneficiaries.

What are the advantages of using drawdown?

Pension drawdown gives you more flexibility with your retirement income. You can keep your pension invested and take out what you need, when you need it, rather than locking everything into an annuity.

This means your pension pot has the potential to grow while you’re drawing from it, and you can adjust your withdrawals to suit your needs or changes in market conditions.

The main advantages associated with pension drawdown products include:

• Flexibility -Compared to the rigid terms of an annuity, drawdown gives you the power to alter the regularity and size of your payments.

• Potential investment growth - A strong performance in the markets could increase your retirement income over time.

• Ability to pass on money - Your family should receive any funds left in your pension pot when you pass away.

What to be careful of with pension drawdown

As with annuities, pension drawdown products might not be suitable for everyone. Factors to consider include:

• A lack of guarantees - Your investments are at the whim of the markets and could fall as well as rise.

• Active money management - You’ll need to keep a close eye on your withdrawals to ensure you don’t run out of cash in the future.

• Investment charges - Fees and charges to keep your money invested could eat into the value of your pension pot if you’re not careful.

• No certainty - There's no assurance your income will end up higher compared with what an annuity would provide.

If you want an idea of what this could look like, try our pension drawdown calculator.

Is drawdown better than an annuity?

Your decision on whether to choose an annuity or pension drawdown will ultimately boil down to your personal circumstances and retirement goals.

Annuities are designed more for retirees seeking a stable, regular income that can sustain them until the end of their life. In comparison, drawdown hands you flexibility and access to the stock market, giving your pension pot the opportunity to grow. The compromise? You’ll have to trade in the reassurance offered by an annuity for a degree of risk.

Think carefully about your risk appetite, the size of your pension pot, and how actively you want to manage your money before committing to any deal. Setting up a retirement income is a huge decision – and one that should never be rushed.

If you’re considering an annuity or pension drawdown, speak to a financial adviser and explore which option might work best for you.

Annuity or drawdown: which is better?

Here’s a quick annuity vs drawdown comparison that emphasises the main features of each pension product – letting you know which one may be better for you.

How much money will I get from an annuity or drawdown?

It’s impossible to provide a clear answer for the level of income you’ll get from an annuity or from a pension drawdown.

Growth in the stock market might result in higher income from drawdown than an annuity. However, a dip in the stock market might shrink your drawdown pot, reducing both your income and how long your money may last.

You should always consider the risk attached to pension drawdown and seek professional financial advice before making a decision.

Can I combine an annuity with a pension drawdown?

You may think your only option is a straight choice between an annuity or pension drawdown. However, there is no reason why you can’t combine both products to give you the right level of flexibility and financial security.

With greater pension freedoms, you don’t need to choose just one option – you could use a mixture of options as part of a blended solution. This is becoming increasingly popular as a way to achieve the perfect balance of protection and choice. It means you could place some of your pension pot in an annuity with guaranteed income and leave the rest invested in a drawdown solution so that it can continue to grow.

Here are two ways you could combine an annuity and pension drawdown:

Option 1: Split your pension pot

You could divide your pension pot into two parts, whether evenly or in whatever proportion suits your needs. One portion could be used to buy an annuity, and the other portion could stay invested in a drawdown plan where it has the potential to grow.

Option 2: Invest in stages

Another approach is to place your entire pension pot into drawdown, then purchase an annuity later in retirement using all or part of your remaining money.

The reasoning behind a combined approach is that as you get older, annuity rates typically improve. Also, if you develop health problems later in life, you may qualify for a higher rate.

Do you need annuity or pension drawdown advice?

Need personalised guidance on which option might work better for you or as part of a blended solution? Just get in touch with our retirement advice service. They can help you understand your options and which might be right for your individual circumstances. Alternatively, request a call back from our pension advisers.

Annuity vs drawdown FAQs

Is a drawdown better than an annuity, or vice-versa? The answer depends on your personal circumstances. Here is a selection of frequently asked questions to help you reach a decision.

What age should I buy an annuity?

You can generally buy an annuity from the age of 55, which is the earliest most people can access their pension pot, and is set to increase to 57 from 6 April 2028. 

Can I withdraw money from an annuity?

The income an annuity pays is set when the contract is purchased and cannot usually be changed. You should therefore carefully consider whether the income it pays will meet your needs before buying.

Can I withdraw as much money as I want from a pension drawdown?

Yes, after taking your 25% tax-free lump sum, the remaining 75% is subject to income tax. Keep in mind there are limits:

• The lifetime tax-free lump sum allowance is £268,275 and the lump sum and death benefit allowance (LSDBA) is £1,073,100. These allowances limit the maximum tax-free lump sums that can be paid whilst you are alive and after your death.

• Taking large amounts in a single year could push you into a higher tax bracket, or may reduce access to some state benefits.

• There is a risk of running out of money with a pension drawdown as your income is not guaranteed and investments could be vulnerable to market fluctuations.

However, planning withdrawals carefully can help you manage your tax liability and ensure your pension lasts throughout retirement.