When planning for retirement in the United Kingdom, individuals often encounter two primary options to convert their pension savings into a regular income: the drawdown pension (commonly known as a living annuity in some countries) and the lifetime annuity (similar to a guaranteed life annuity). Understanding the differences between these two products is crucial for making informed decisions that align with your financial goals and retirement needs.
What Is a Drawdown Pension?
A drawdown pension, also referred to as a flexible or income drawdown, allows retirees to keep their pension invested while withdrawing an income as needed. This product offers flexibility in how much and when you take money from your pension fund. The key advantage is that the remaining capital stays invested, potentially growing over time, but it also means the income can fluctuate based on investment performance.
What Is a Lifetime Annuity?
A lifetime annuity involves using your pension pot to purchase a guaranteed income for life from an insurance company. In return, you receive a fixed or escalating income, regardless of how long you live or how investments perform. This option provides certainty and security but usually means giving up control of the pension capital once the annuity starts.
Comparing Drawdown Pensions and Lifetime Annuities
| Feature | Drawdown Pension | Lifetime Annuity |
|---|---|---|
| Income Flexibility | High – choose when and how much to withdraw | Low – fixed or predetermined income |
| Investment Control | Remains invested under your control | No – capital is used to buy the annuity |
| Income Stability | Variable – depends on market performance | Guaranteed – fixed or escalating income |
| Risk | Investment and longevity risk borne by you | Longevity risk transferred to insurer |
| Capital on Death | Remaining pension fund passes to beneficiaries | Usually no capital left; some options include a guarantee period or joint-life cover |
| Potential for Growth | Yes, if investments perform well | No – income fixed regardless of market |
What Happens to the Capital on Death?
In a drawdown pension, any remaining pension capital typically passes to your nominated beneficiaries, often tax-free if death occurs before age 75, or subject to income tax if after age 75. This flexibility allows for potentially passing on wealth to loved ones.
Conversely, with a lifetime annuity, the capital is usually used up in purchasing the annuity income, so there is no remaining fund to pass on. However, some annuities offer options such as a guarantee period (e.g., payments continue for a minimum number of years even if you die) or joint-life annuities that continue payments to a spouse after death.
Which Option Is Right for You?
Choosing between a drawdown pension and a lifetime annuity depends on your appetite for risk, need for income flexibility, and desire to leave a legacy. Drawdown pensions suit those comfortable with investment risk and wanting control over their pension funds. Lifetime annuities appeal to retirees seeking stable, guaranteed income without market worries.