Income Drawdown vs Annuity

As the new pension flexibility reforms came into effect in April 2015, it has been estimated that the number of people opting for an annuity would reduce by up to 70% or more.

Since retirees now have a lot more options in accessing their pension pots, why risk being locked with an annuity that may not provide enough retirement income?

What most people do not realize is that more the options you have, greater the risk of making an incorrect decision that you may have to live with.

Irrespective of whether you reached pension age before April 2015 or after it, you must seek independent financial advice before you make any decision regarding your pension pot.

Is Flexi-access drawdown a better choice than buying an annuity with a large part of the pension pot?

Flexi-Access Drawdown

One of the most crucial changes made to Pension Laws, Flexi-Access Drawdown allows you to take a quarter of your pension pot as a tax-free lump sum cash amount and reinvest the remainder into funds of your choice, which will then provide you with taxable income that you can use when you wish.

You can handpick the funds that you think will perform well and be able to produce an income you desire. However, the income may not be permanent and will be dependent on the performance of your investments.

You may choose to start taking the income right after you invest or you may defer it for some time.

Alternatively, you can also convert the remainder of the pension pot into income drawdown which allows you to take small sums of money from it. Each time, 25% of the money can be taken as a tax-free cash amount.

The Risks

The risks of using the Flexi-access drawdown option are many, especially if you are making the decisions yourself.

Here are some of them.

  1. You may be tempted to take out too much money during the earlier years of your retirement
  2. You may start taking a higher income and your investments may not match this level causing your future payouts to reduce
  3. You may outlive your pension pot
  4. There may be limited funds to choose from
  5. Charges may be applicable
  6. You may not be aware of the tax implications

Drawdown and Tax 

Any money that you will withdraw from your pension pot will be added to your yearly income and will be subject to income tax.

If you withdraw larger amounts, then the tax bracket will be higher.

What should I choose?

Your choice depends completely on your personal circumstances and objectives.

  • Are you a ‘risk-averse’ person? Then you are better off choosing the stability that a fixed retirement income can provide you with. Buy an annuity with a part of your pension pot. Once again, there are multiple choices and you should do your research and make a decision.
  • If you can live with capital risk, then you can think about Flexi-access drawdown and invest the remainder in funds. You can draw an income that will not be stable.
  • On the other hand, if your risk tolerance is somewhere in the middle, then you need to work out how much money you can afford to lose before it starts to affect your lifestyle habits. Set a limit and keep the rest aside or use it to secure a retirement income.

Most experts recommend that you at least have a fixed retirement income that can meet your basic expenses. This will ensure that at least your basic standard of living remains protected.

This fixed income can be a mix of a state pension, employment pension schemes and from an annuity that you can purchase with a part of the pension pot.

You can also choose to protect it against inflation so that the buying value of the fund remains the same even after 10 or 15 years.

Seeking Expert Guidance 

No matter how informed you are, it is better off to seek professional advice before making crucial decisions about your pension pot.

You can always consult Pension Wise, the free government-backed service for impartial advice.