Income Drawdown Vs Pension Annuity

When you want to stop putting money into your pension fund and decide you would like to start drawing an income from it, there are two main types of income facility to consider, the Income Drawdown and the Annuity.

What is Income Drawdown?

The income drawdown is the main alternative to buying an annuity when you wish to start to make use of your pension fund.

Historically it has only been possible to buy an annuity with your pension, but in today’s society, income drawdowns are now becoming a viable alternative for many.

“the main difference to the income drawdown from the annuity is that the drawdown takes money directly out of the pension fund that you have built up, rather than using that fund to buy an annuity which will pay you a fixed amount every month”

And though this means you have greater control over where your money is invested and how much you withdraw, the value of your income is not guaranteed.

If you choose to draw down increased levels of income over a long period of time or your investments start to fail, then your fund may not be able to provide a reliable income for your entire life.

However, the drawdown does give greater control over what happens to your fund when you die.

Your remaining spouse could choose to continue to operate the income drawdown policy as usual. They could take the entire remainder of the fund and use this to buy their own annuity. Or they could liquidate the draw down facility altogether and take the cash lump sum, though this is liable to a 55% tax penalty under current legislation.
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The choice would be up to them and makes the entire drawdown facility much more of a flexible option for those that are left behind.

The key advantages to an income drawdown policy are:

  • Greater control over the capital
  • Greater flexibility over how much income you draw
  • Greater alternatives for the remaining money when you die

However the drawbacks to such a decision are:

  • No guarantee over the level of income you will receive
  • No guarantee that the fund will provide income for your entire retirement period

What is an Annuity?

At the time you wish you start drawing an income from your pension fund it is possible to use either your entire fund or the balance less any lump sum withdrawal to buy an annuity.

An annuity is a form of insurance policy which will guarantee to pay you a regular fixed sum of money for the rest of your life.

Unlike an income drawdown policy, an annuities value will not change over time, but you could choose to link it to inflation to provide some protection against the future cost of living.

You have no control over how your money is invested and you have no control over how much you receive. All the payments are agreed up front and fixed for the duration of your retirement. However the pot will never run dry and payments will continue no matter how long you live.

It is possible to maximise the value of the payments made under the annuity by advising your insurance company of any situation of illness that will reduce your life expectancy. The less time you are calculated to expect to live, the higher your income could be however the level of payments will be set by them and is out of your control.

When you die, an annuity can still provide an income to your partner if you so wish. However, this does have to be arranged up front and there is no opportunity to liquidate the annuity under the standard agreement. The payments are therefore more controlled but they are guaranteed.

The key advantages to the annuity are:

  • Guaranteed Income for the rest of your life (should you choose the guaranteed option)
  • No fear that the pot will run dry
  • Will continue to pay out no matter how long you live

However the drawbacks to such a decision are:

  • No control over the capital sum
  • Less options for remaining spouses when you die

If you need advice on whether an annuity, a drawdown or a combination of the two would be the best option for your pension fund, speak with an independent pension adviser who will be able to provide you the advice you need to ensure you make the most of your investments.

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This article was written by Steven Keogh

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