Annuities¹ are products that offer you a guaranteed income in your sunset years. It’s typically a contract with an annuity lender, who is mostly an insurance firm, to provide you with some capital, in exchange for a lump sum at the initial stages of the plan, which is drawn from your pension fund. A pot of cash doesn’t limit the annuity income, so it’ll continue paying out until you pass away.
There are more than a few types of annuities in the financial market. Some pension annuity schemes pay a fixed income and others that pay some revenue that increases with time. You can also opt to purchase a joint-life annuity that’ll cover both your spouse or civil partner.
The Benefits and Drawbacks of Annuities That You Need to Know
So let’s get down to business.
Some of the perks of annuities schemes include:
- They don’t run out
- They maintain the same level of revenue (or increase over time)
- Annuities remain unaffected by inflation rates in the stock market or global economy
- Once you set up an annuity, you don’t have to ensure continued management of the plan
Some of the disadvantages of annuities include:
- Your income is usually limited by the annuity rates that are on offer
- Annuities can’t be inherited when you pass on. However, in the current market, you can opt for one that will continue to pay a reduced amount to your spouse
- Once you’ve purchased an annuity, you can’t go back on your word or trade it in
Drawdown pensions1 are a way of taking an income from your pension fund that remains invested in the stock market. You can withdraw the amount you’d like, as long as the capital is there, and these drawdowns are usually taxed as income.
How much you’ll get from a pension drawdown is dependent on the fund’s performance and your needs. The pension plan isn’t guaranteed for life.
There’s no cap on the amount you can take out at any time – as long as the finances are available.
The Pros and Cons of Drawdowns
Some of the benefits of having a pension drawdown include:
- You can choose to either increase or reduce your income whenever you want
- You can take a significant lump sum amount if you want
- Your heirs can receive an inheritance (from the remaining capital, tax-free)
- You have the freedom to control your pension pot as you’d like. Therefore, you have the right to change your mind and purchase an annuity later on
Some of the downsides to having a pension drawdown include:
- Your capital can run out entirely
- Your pension pot stays capitalized. Therefore, it’s susceptible to stock market falls
- Pension drawdowns require on-going maintenance and management by you or your advisor
- With the drawdown plans, there’s no guarantee that you’ll receive a better income package than if you take the annuity
Pension Drawdowns vs Annuities – What’s the Best Option for You?
Life after retirement can be hectic if you don’t have a solid plan or financial assets. So, when figuring out which investment plan would be best suited for you, you need to assess your circumstances including your life expectancy (based on your health), your goals for the sunset years, and your risk appetite. Based on the size of your pension fund, you might not have to select one investment option. With that in mind, here’s a look into annuity vs drawdown.
Drawdowns are considered to be more flexible than annuities, but they do carry more significant risks. With these schemes, you can move your cash into one or more pension funds and alter the amount and regularity of your withdrawals.
You can apply a test and learn strategy depending on the fund’s performance and the income’s potential to double. Nonetheless, if your investment plan isn’t managed carefully, your cash can run out early on in your retirement.
Annuities offer you certainty when you transition into the sunset years. However, they lack the flexibility that pension drawdowns offer. When you buy a pension annuity2, you can’t go back on your word. The amount of income and frequency of payment are set in stone. Therefore, it’s crucial to make sure that you get the ideal annuity that perfectly suits your needs.
When it comes to longevity, with the pension drawdown schemes, there are no guarantees that the income you withdraw will remain stable for a prolonged period. It’s because when you reinvest your savings, they become susceptible to the stock market performance.
You can use an annuity to guarantee an income for an extended period. A lifetime annuity is used to offer you a basic income for life, and it’ll continue paying out as long as you’re alive. A temporary pension annuity, on the other hand, will payout on a provisional basis, and they offer an assured income for a set period.
If you cross over to the light before you reach 75 years of age, any heirs you choose can inherit the amount of capital that’s left in your pension drawdown, tax-free.
The type of pension annuity you buy will determine if it’ll continue to pay out when you pass on. If you get the single-life annuity, it’ll only pay an income to you, and when you pass away, all the remaining funds will be retained by the insurance company. Nevertheless, if you opt for the joint-life annuity scheme, you can select a spouse or civil partner to get income payments on your behalf until they pass on.
Annuity or Drawdown?
When taxes become the primary concern, there’s typically no significant difference between annuities and pension drawdowns. As long as you’re aged 55+, both pension schemes can enable you to withdraw up to 25% as a tax-free amount.
When it comes to drawdowns, the remaining finances will be reinvested, whereas, for the annuities, the extra cash will be used to buy an annuity product. Income tax will be pertinent to the supplementary income you draw, in line with the existing income tax rate thresholds.
Got Questions? Check These First
What’s A Drawdown Pension?
A pension drawdown helps in keeping your pension fund invested and offers you the flexibility of dictating your income after retirement. The amount of capital you’ll get will depend on the pension pot’s performance and your specific needs. Drawdown plans aren’t guaranteed for life. Nevertheless, there’s no cap on the amount you can withdraw at any point – as long as the funds are available.
Is A Pension Drawdown A Good Idea?
Yes, it is. Some of the reasons why pension drawdown plans are incredible include:
- They offer you investment growth opportunities
- They provide you with added flexibility
- Pension drawdowns allow you to transfer your savings to your beneficiaries
When is Buying An Annuity A Bad Idea?
Annuities work in the same manner as insurance products and pay out a surefire income for a fixed term or until you pass on. Pension annuities are great, but they can be a terrible idea since:
- Nothing will be passed on to your heirs unless you decide to pay extra
- Annuities can be expensive
- Keeping up with the inflation rates will cost you an extra amount
Can You Lose Your Cash in An Annuity?
Yes, you can. The value of an annuity typically changes depending on the performance of your investments, meaning that you can lose your cash, including your principal if you have a variable annuity (if your investments don’t perform well). A variable annuity5 also tends to feature higher fees, thus increasing the chances of you losing your capital.
If you want to make sure that your money will last as long as possible, the best option is a drawdown. A buy-an-annuity would be great if you are worried about inflation and don’t need immediate cash from your investment. The decisions aren’t easy, but it’s essential to get informed before making any changes in retirement plans.