What is an annuity?

An annuity is designed to guarantee a strong financial income throughout retirement. Retirees can purchase an annuity by using the funds they have built up over the years in their pension to provide a regular income every month for the rest of their lives. This type of arrangement is ideal for those who want to enjoy the nicer things in life when they retire. It is important to bear in mind that an annuity arrangement is for life. This means that you will get your payouts no matter when you pass away, but should consider that if you die early, the pension provider will get to keep the rest of the funds you have saved away. If you live a long life, you’ll end up receiving more from the annuity provider than they had expected to pay out. Staying healthy and doing your best to ensure a long life expectancy can help guarantee a good income from an annuity.

What is an income drawdown?

Income drawdown is another way to ensure regular income from your pension pot, and gives increased flexibility. New legislation means that you can keep your pension invested and only withdraw a certain amount every year, rather than choose to have an annuity. Your income will be taxed in the same way as it is when you work. A benefit of income drawdown is that when you pass away, your estate benefits from any remaining funds left over, and can be passed on to relatives. This is unlike an annuity, which stops when you die and cannot be passed on. You can be taxed on an income drawdown, depending on the age at which you pass away.

Are you wondering whether to set up an annuity or drawdown for your retirement? Don’t sign up for anything until you’ve spoken to one of our advisors at Financial Advisor UK. We offer a national network of professional FCA-registered and approved experts who can offer you the best advice and search the market for the right deals for your financial situation. Together we can help you make the right choices for your financial future.

Advantages of annuities

Some annuities are linked to investments. A big advantage of this is that the money used to purchase the annuity is tax-free. When you take out 25% of your pension to buy an annuity, you can potentially make money on your income without being taxed. This type of product is known as a ‘with-profit annuity’, as it is linked to an investment. Investment-linked annuities also have no yearly contribution limit, so you are able to accumulate capital tax-free. This is especially helpful if you are looking to increase your overall pension pot.

Disadvantages of annuities are that, being investment-linked, there is a potential risk that you could lose capital. Some annuity providers do state in their contracts that a minimum income will be paid, but it is worth bearing in mind that your income could be greatly reduced if your annuity wasn’t invested wisely or became affected by market activity. There may also be a limit on how many times you can withdraw money from your annuity. Fees may be applied if you go over the maximum number of times in which you can withdraw funds. In order to decide whether an annuity is right for you, always speak to a financial advisor such as those offered through Financial Advisor UK.

Is an annuity right for me?

Many annuity providers will have pros and cons depending on the type of arrangement you have with them. Different types of annuity include:

• Lifetime annuities (providing a fixed income until you pass away)
• Enhanced annuities (that pay out a higher, fixed income – eligibility applies)
• With-profit annuities (annuities linked to investments)
• Deferred annuities (investment-linked annuities that are left to accumulate for a set period of time before funds can be accessed)

Annuities vs. pension drawdowns

Having a pension drawdown enables you to move your capital into one or multiple funds as you wish. You can also withdraw as much or as little as you like, while controlling the frequency of your withdrawals. Bear in mind that drawdowns do not guarantee a fixed level of income like annuities, so unless you plan very carefully, you might end up spending too much of your money too early into retirement. Some retired people like the flexibility offered by a drawdown plan, while others prefer to have a guaranteed income from an annuity.

How do pension drawdowns work?

With a pension drawdown you can take 25% of your pension pot as a tax-free sum, and then move the rest of the capital into a flexible income plan that allows you to take a drawdown of income whenever it suits. Some people set up regular payments for a frequent income, while others decide to only use the drawdown when they need it. There are two main types of drawdown product – pension drawdown and capped drawdown (though the latter has since been phased out since April 2015).

Pension drawdowns were introduced as of April 2015. With this type of drawdown plan, there is no limit on the amount you can take from the drawdown at any time. With a capped drawdown, there is a cap on the amount of money you can take out of the drawdown. If you already have a capped drawdown plan, new rules have come into force that apply when you exceed your capped income. If you already have some or all of your pension savings in a capped drawdown plan, you’ll need to review the government’s new guidelines on pensions to see how the new rules will affect you.