Fixed or flexible income in retirement?

A closer look at annuities and flexi-access drawdown.

With the introduction of pensions freedom you can now take greater control over how you use your pension to fund your retirement. You have the choice of taking your money as cash, or using it to provide a fixed or flexible income via an annuity or a flexi-access drawdown plan. Whilst the cash option allows you to flexibly access your pension as a single or series of cash lump sums, here we'll look at the choices available if you were to turn your pension savings into an income. 

What's right for you may depend on factors such as your health, inflation, tax, or any financial responsibilities.

When considering the income options, what's right for you may depend on factors such as your health, inflation, tax, or any financial responsibilities you have for others. 

Your attitude to risk may also influence your decision. For example, if you prefer the security of knowing that you'll have a fixed income for life that isn't dependant on the performance of another type of investment, then you may feel that an annuity is for you. Alternatively, depending on your individual circumstances, flexi-access drawdown may provide more flexibility with how you access your pension savings. 

The value of your investment can go down as well as up so you might get back less than you put in. If you take more money from the plan than the amount your investment has grown by, the value of your investment will be less than you’ve put in.

So what is an annuity? 

An annuity will provide you with an income for the rest of your life, regardless of how long you live. Although an annuity comes with a guaranteed income in retirement, what you can afford to buy with your money might change over time due to inflation. Inflation is a measure of how the price of goods and services is changing and so could impact the purchasing power of your money over time. There are different types of annuity, some of which are designed to protect against this. 

The options you choose when you buy an annuity could affect what happens to your pension when you die. For example:

  • If you've chosen a guarantee period and die within this period, the annuity will continue to be paid until the end of this time. 
  • If you bought a joint life annuity, payments will continue to the second person at the level you chose, until they die - these payments may be taxed as income at their marginal rate. 
  • In all other cases, when you die, your income payments will stop and any loved ones will not receive an income after your death.

It's important to understand the various options available after you die. Further information on what happens to the annuity can be found at gov.uk.

What is flexi-access drawdown?

Flexi-access drawdown gives you the flexibility to take any number of income payments from your pension savings, once you have transferred them to the drawdown plan, as and when you want to. You maintain control over how you invest your fund. 

Leaving your fund invested in flexi-access drawdown leaves you open to the risk that you could lose money if the funds you've invested in don't perform well and the value goes down. Your flexi-access drawdown pot could also run out if you make excessive withdrawals.

If you die before you turn 75, the death benefits from your pension will usually be free from income tax for your beneficiaries. If you die after reaching age 75 the death benefits are normally taxed as the beneficiaries' income. For more information please visit gov.uk.

The benefits and considerations of buying an annuity or drawdown

An annuity...the benefits

  • Gives you a guaranteed income for life.
  • Guaranteed income for a spouse, partner or a dependant if you select that option.
  • There are level and increasing income options available.

The considerations

  • If you haven't shopped around, your income from your provider may be lower than you could get elsewhere.
  • If you and/or your partner have any certain health and/or lifestyle conditions, you could be entitled to a higher income. Other providers may cover different conditions which means you could get more income elsewhere.
  • Check if your pension plan has any guarantees built into it as this could potentialy enhance your annuity income.
  • Any entitlement you have to any means tested benefits you receive, such as Housing Benefit or Income Support, may be impacted.
  • If you have debts, any creditors could have a claim on any money you receive.
  • Before you purchase an annuity, consider that once taken out, you cannot currently change your mind.

Flexi-access drawdown...the benefits

  • You're in charge of how your money is invested. It is up to you how and when you take your money.
  • If you wanted to, you could purchase an annuity later.
  • Any money you have remaining in your plan when you die can be passed on to your loved ones although there may be tax implications depending on your particular situation. 

The considerations

  • If investment returns are poor and/or a high level of income is taken, the value of your drawdown fund may be significantly reduced. This could result in lower, or no income in the future and you may also not get back what you put in.
  • The risk is your money could run out and you could have to rely on another source of income, for example, the State Pension.
  • If you have a guarantee on your pension plan this may be lost if you take your pension savings as a drawdown income.
  • Any entitlement you have to any means tested benefits you receive, such as Housing Benefit or Income Support, may be impacted.
  • If you have debts, any creditors could have a claim on any money you receive.
  • Before you convert your pension to a drawdown, consider that you may be restricting the amount you can invest into a pension in the future.
  • You may not be able to take a drawdown product without taking advice.

Remember that it doesn't have to be an either-or choice between buying an annuity and keeping your money invested in a flexi-access drawdown plan. You could opt for a mix of the two – purchasing an annuity with some of your pension pot for a guaranteed income and have some invested in flexi-access drawdown, where you can draw an additional income as and when you need it. When you’re deciding what you want to do with your pension pot, you should consider all the options and their tax implications. Pension providers offer different products with different features and options, including the product terms, rates, funds or charges that might be appropriate for your individual needs and circumstances.

That’s why it’s important you shop around. So whatever you decide to do – whether that’s an annuity, drawdown or something else, it’s the right decision for you.

For some products, like annuities, shopping around will help you get the highest possible income. Your health and lifestyle can increase the amount of income you can get. Different providers may use different criteria to assess your health and lifestyle conditions. This is known as an enhanced annuity. Prudential do not offer enhanced annuities but you may qualify for an enhanced annuity with another provider and get a
higher income. That’s why it is very important that you should shop around. 

Be mindful that investment scams exist so it is important to remain vigilant and check the facts before you make any investment decisions, as you could lose money.

We are not recommending a particular retirement option, or course of action, over another.

We recommend you use Pension Wise, a new service from the government which offers free and impartial pensions guidance. This service is available over the internet, over the phone and face to face.

Find out more at pensionwise.gov.uk

If you are a member of an occupational pension scheme, the options available to you may vary, so please contact your scheme provider. If you have a pension with guaranteed benefits where their value is £30,000 or more, legislation requires you to take financial advice when looking to convert into a flexible option, such as taking the pension pot as cash or transferring to a flexible income option.  In addition, if you want to transfer out of a defined benefit scheme you are also required to take financial advice.

You might need to pay tax depending on your circumstances and the options you choose. Tax rules can also change in the future. For more information please visit gov.uk.

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