Annuity or drawdown?

At some point every defined contribution pension has to become money you can spend, and there are two fundamental ways of doing it. You can hand the capital to an insurer in exchange for an income guaranteed for life. Or you can keep it invested and take what you need, accepting that the pot can fall in value and can run out.

This is the decision most people find hardest, partly because the two options fail in opposite directions. An annuity can leave you feeling you gave away your capital for a poor return. Drawdown can leave you at 90 with a depleted pot and no way back. Both regrets are real.

What an annuity actually is

You give an insurer a lump sum. They pay you an income for the rest of your life, however long that turns out to be. The capital is gone; the income is guaranteed.

The options that matter:

Single or joint life. A joint-life annuity continues paying, often at a reduced rate, to your surviving spouse. It costs more up front. Where one of you would struggle on a single income, it's worth serious thought, and the reduction level — commonly half or two-thirds — is a real decision, not a default to accept.

Level or escalating. A level annuity pays the same cash amount forever, which sounds fine until you notice that inflation halves its purchasing power over roughly two decades. An escalating annuity starts materially lower and rises each year, either at a fixed percentage or in line with inflation. The crossover point where the escalating version has paid more in total typically sits somewhere in the second decade. Choosing level income is a bet on not living long enough for inflation to matter.

Guarantee period. For a modest cost, you can guarantee payments for a set number of years regardless of when you die. It removes the worst-case scenario where someone dies shortly after buying and their family receives almost nothing.

Enhanced and impaired terms. This is the one to know. If you've health conditions — heart problems, diabetes, high blood pressure, a cancer history — or if you smoke, or are overweight, you can qualify for a higher income, sometimes considerably higher, because the insurer expects to pay it for less time. It's the most under-claimed advantage in the market. Anyone buying an annuity without going through full medical and lifestyle underwriting is potentially leaving a large amount of money on the table.

Why annuities are worth another look

Annuity rates track long-term gilt yields, and gilt yields spent the 2010s on the floor. Rates became so poor that annuities acquired a reputation as an obviously bad deal, advisers largely stopped raising them, and a generation of savers absorbed the idea that drawdown was simply the modern answer.

Yields rose sharply from 2022 and annuity rates rose with them. The product that deserved its poor reputation in 2016 is a materially different proposition now.

There's also a structural feature that gets overlooked: an annuity pays you from a pool that includes people who die early. That cross-subsidy — mortality cross-subsidy, technically — is income no invested portfolio can replicate, and it grows more valuable the older you're when you buy. A 75-year-old buying an annuity is getting a rate that an invested portfolio would struggle to match safely.

What drawdown actually is

You move the pension into a flexi-access drawdown arrangement, keep it invested, and take income as you choose. Up to 25% is available as tax-free cash, subject to the Lump Sum Allowance of £268,275; the rest is taxable when drawn.

The advantages are real:

• Flexibility. Take more in the good years, less in the lean ones, nothing in a year you don't need it.
• Continued growth. The pot stays invested, which over a retirement lasting thirty years matters enormously.
• Death benefits. Whatever is left passes to your beneficiaries, which an annuity generally doesn't.
• Reversibility in one direction. You can annuitise part or all of a drawdown pot later. You can't un-annuitise.

The risks are equally real, and they aren't just "markets might fall". The specific danger is sequencing risk: a market fall in the first few years of drawing, when you're selling units to fund income, can permanently damage a pot in a way the same fall ten years later wouldn't. There's also the plain fact that you might live longer than the money does, and no amount of careful management fully removes that.

The honest comparison

The temptation is to compare expected outcomes and conclude drawdown usually wins. On average, over long periods, an invested pot probably does produce more total income than an annuity bought at the same moment.

But "on average" is doing a great deal of work in that sentence. You don't get an average retirement. You get one retirement, with one sequence of returns, and one lifespan.

What an annuity actually sells isn't return. It's the removal of two risks that can't be diversified away: the risk of living a very long time, and the risk of a bad market sequence at the wrong moment. Judged as an investment it often looks mediocre. Judged as insurance — which is what it's — it looks quite different.

Which one fits you

There's no general answer to this, and anyone offering you one without knowing your circumstances is guessing. What the choice actually turns on is your own position: your attitude to risk, how certain your spending is, what other guaranteed income you already have, your health, whether anyone depends on you, and the size of the pot relative to what you need from it.

As a very rough steer, and nothing more than that:

An annuity tends to appeal to someone who is risk averse, who has a reasonably clear idea of the income they need, and who doesn't expect that figure to change much. If the prospect of a market fall affecting your income would genuinely worry you, that's a meaningful signal in itself.

Drawdown tends to appeal to someone who wants to vary what they take — spending more in the active early years and easing back later, or simply keeping the flexibility to respond to whatever happens. It also matters to people for whom leaving something behind is a priority.

Both of those are illustrations, not rules. There are risk-averse people for whom drawdown is clearly right, and flexible spenders who are better served by locking in a floor. Plenty of people use both, in varying proportions, and the balance is a genuine planning question rather than a default.

One structure worth understanding

A common approach — not the answer, but worth knowing about because it comes up often — is to separate essential spending from discretionary spending, using the split described in Working out what you actually need.

The idea is to cover the essential figure with income that arrives regardless of markets: State Pension first, any defined benefit pensions next, and an annuity to bridge whatever gap remains. Everything above that line stays in drawdown.

Where it suits someone, it means a bad decade in markets affects holidays rather than the electricity bill, which makes it considerably easier to hold your nerve and avoid selling at the worst moment. Whether it suits you depends on how large the essential figure is relative to your pot, how much guaranteed income you already have, and what you'd be giving up in flexibility to get there. For some people the answer is that almost all of it should be guaranteed. For others, none of it needs to be.

It also allows for timing. You don't have to annuitise at 60. Buying later means a higher rate, more mortality cross-subsidy, and better information about your own health — so a common approach is drawdown through the early active years, with a decision point in the mid-seventies about locking in a floor.

What the 2027 changes do to this

From April 2027, unused pension funds are expected to fall within the estate for inheritance tax.

This affects the two options differently. Money used to buy an annuity leaves your estate at the point of purchase — the capital is gone, so there's nothing left to tax. A drawdown pot remaining at death is the thing the new rules are aimed at.

For an estate comfortably below the nil-rate bands this changes nothing. For an estate above them, it's a genuine factor in the comparison, and it points in the opposite direction from the usual drawdown-preserves-your-legacy argument. It's one more reason not to treat this as a decision made once at 60 and never revisited.

Before you decide

This is regulated advice territory, and legitimately so. The decision is largely irreversible, it interacts with tax, inheritance and your spouse's future security, and the differences between products and underwriting terms are substantial enough that shopping around isn't optional.

If you take one thing from this page: never accept the annuity your existing pension provider offers you without comparing the open market, and never buy one without full health and lifestyle underwriting.

This article is for general education only and isn't personal advice or a recommendation of any product. Annuity rates, terms and tax treatment depend on individual circumstances and change over time.

Related in this series

• Turning pensions into income: the five decisions
• Working out what you actually need
• How much can you take without running out?
• What happens to what's left