Annuity vs drawdown – what’s the difference?

When the pension freedom reforms came into force in 2015, the proportion of buying an annuity as a retirement income option fell to around 10%, and it’s remained close to that level ever since. That is despite a rise in annuity rates in recent years.

Some people want the security of a guaranteed income, whilst others are happy to manage a drawdown pot and investments because they value the flexibility to plan their income, and the more generous death benefits available. Others like to combine both approaches.

Find out what the main differences are between annuity and drawdown, and why over 90% of pension savers choosing an income option opt for pension drawdown.

What’s the difference between annuity and drawdown?

What is a pension annuity? 

A pension annuity is a product you buy from an insurance company – you exchange all or part of your pension pot for a guaranteed income for the rest of your life. 

The income you'll get from an annuity is set at outset and the rates you’re offered will depend on factors like your age, health, and even where you live. You can also build in options like inflation protection or a spouse’s or dependant’s income if you pass away. Both these options will lower your starting income but can give you and your family valuable protection. 

Buying an annuity with your pension pot is an irreversible decision, so it’s crucial that you shop around for the best deal.  

Learn more about annuities and how they work 

What is a drawdown pension?  

With drawdown, after any tax-free lump sum you’ve taken, the funds stay invested and you can choose how much income to take, and when. At AJ Bell, this would be within a Self-invested personal pension (SIPP).

Anything you do withdraw under drawdown is taxable, just like the salary you earn in your working life. 

The flexibility of drawdown means you don’t have to take anything right away and you can leave your SIPP invested, giving it more time to grow. This might suit you if don’t need the income just yet or you are looking to manage your income tax position and avoid tipping into another tax band.

Another plus point of drawdown is that it isn’t a final decision. You can continue in drawdown or buy an annuity with your drawdown funds in later life, if that suits your circumstances at the time. If you stay in drawdown, anything left in your drawdown pot can be passed onto your beneficiaries when you die.

Some people like to enter drawdown to bridge the gap between winding down at work and claiming their state pension.

You should keep in mind that the income from drawdown is not guaranteed. You’ll need to be comfortable managing your pension investments or pay for a financial adviser to do this for you. Your drawdown pot could be depleted more quickly than you had planned if you take a high level of income, or you sell investments to fund your withdrawals when markets have fallen.

Taking a flexible income from your drawdown funds will also trigger something called the money purchase annual allowance. This allowance covers what you can pay into money purchase pensions (like SIPPs or Ready-made pensions) going forward and is set at £10,000 a year. Although this is much lower than the standard pension annual allowance, it might not be an issue if you’ve stopped working and have no plans to top up your pension in the future.

Find out more about SIPP drawdown

Can I get the best of both options?

If you like the sound of both annuity and drawdown, you can mix and match between the two of them.

For example, you could buy an annuity with part of your pot to give you a base or core level of guaranteed income and move the rest in drawdown. 

The drawdown income can be turned on or dialled up and down depending on your needs, and the drawdown pot has the potential to benefit from investment returns and growth over time. You could choose to take nothing at all for now. Although the portion you used to buy an annuity has been paid to the insurance company at the start, the funds that remain in drawdown are still available to take a future income from or even used to purchase an annuity in the future.