Fixed or flexible income in retirement?

A closer look at annuities and flexi-access drawdown.

The pensions freedom that came into effect in April 2015 means that 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. If you prefer to be more involved in deciding where your pension savings are invested, to potentially increase your flexible income, then a flexi-access drawdown plan might appeal to you. While the rewards may be higher, it's a riskier option, because the money you leave invested can go down as well as up - so you may not get back what you 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 if inflation changes. Inflation is a measure of how the price of good 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 will 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.

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 the rest of your fund. It's also up to you what you do with the money you take out so it's important you can fund your retirement because there are no guarantees that your money will last. 

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, any funds that are left in your plan will be paid to your nominated beneficiaries. In most cases this will be tax-free. If you die at 75 or over, then any money your beneficiaries take out of the fund will be taxed as their income.

The benefits and considerations of buying an annuity or drawdown

An annuity...the benefits

  • Gives you a guaranteed income for life.
  • A lower-risk way to use your pension fund.
  • 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.
  • If you have a guarantee on your pension plan this may be lost depending on which type of annuity you choose and may result in you receiving a lower 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. 

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.
  • You may need to pay additional tax or reclaim overpaid tax from HMRC so this could include paying a higher rate of tax on this and any other income.
  • 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 tax-free into a pension in the future.
  • You may not be able to take a drawdown product without taking advice.
Remember you can opt for a mix of the two if you want to.

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 a flexi-access drawdown, where you can draw an additional income as and when you need it. 

Whatever you decide to do with your pension, you don't have to stay with us. You should shop around and, depending on the choices you make, you may be able to get a higher income elsewhere.

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. You might like to try our retirement planning tool to help you make a decision.

In addition to the support we offer, we recommend that, from age 50, you seek impartial guidance from Pension Wise, the free service from the government that is available on the internet, over the phone or face to face.

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.

Tax rules require careful consideration and may not reflect your individual circumstances so your actual liability may be higher or lower. The above is based on our understanding, as at July 2015, of current taxation, legislation and HM Revenue & Customs practice, all of which is liable to change without notice. For more information please visit www.gov.uk.

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