It’s important to make the right decisions at retirement, particularly as some decisions are irreversible.

One of the most important considerations for people with larger funds is whether to buy a lifetime annuity at retirement or to choose income drawdown?  To help, we’ve produced a comparison between the two options.

First a word of warning: The annuities market is becoming increasingly complex with many new and innovative products. You can find out more about the main types of annuity here.  It would be difficult, and potentially very confusing, to compare each of these with income drawdown so we’re using a ‘conventional’ annuity in the comparison that follows. This is the most popular type of annuity accounting for the majority of annuity sales each year.  However, many of the newer products are gaining ground and we will try and mention one or two of these where it‘s relevant to do so.

Here are the 6 key criteria we think you should consider before you make any decision:

• Guaranteed income for life
• Mortality cross subsidy
• Ability to vary income
• Investment performance
• Protection on death
• Option to transfer

Guaranteed income for life

A lifetime annuity guarantees an income payable for the rest of your life.  The reassurance and the peace of mind the guarantee provides are worth a lot to many people. 

While there are regulations imposed on income drawdown schemes to prevent your fund running out of money, it is a possibility.  Even if the money doesn’t run out completely your income could be significantly reduced if your investments perform poorly.  

Mortality cross subsidy

This is a technical expression, but it’s a relatively simple concept to explain. With an annuity, the amount you receive is made up of two elements: The return on the investments the insurance company holds plus an additional amount.  This additional amount is based on the insurance company’s estimate of how many people will die before they receive the full value of their investment.  While many people dislike annuities for exactly this reason, this feature does actually boost the income you receive from an annuity.  This is commonly known as the mortality cross subsidy. There is no comparable feature in income drawdown.

Ability to vary income

The most popular form of conventional annuity is a ‘level’ annuity. This means that the income is fixed at outset and does not change throughout life. Or you can buy a conventional annuity that increases each year and there are some annuities where the income can vary, but income drawdown generally offers far greater ability to vary income. 

Investment performance

Income drawdown allows you to keep your pensions savings invested giving the potential for growth.  However, this means you take the investment risk and your fund could go down if stock markets fall. With a conventional annuity the insurance company takes the investment risk.

Protection on death

If you die before age 75, whatever remains in your income drawdown fund can be left to your partner and any dependants. The fund available will depend on its performance and how much you have withdrawn. You can purchase death benefits from a conventional annuity in exchange for lower income.

Option to transfer

If you buy a lifetime annuity you can’t subsequently decide to transfer to another product. It is a one-off, irreversible decision. With income drawdown you can transfer your fund to another provider or buy an annuity at any time up to age 75 when you must do so.

If you are uncertain which route to select, we highly recommend you talk to an Independent Financial Adviser

Next retirement guide