If you’re close to retirement or have retired and using your pension for drawdown, should you consider a pension annuity?

A pension annuity is where you use the funds inside your defined contribution pension to purchase a guaranteed income for the rest of your life.

Pension annuities have had a bad reputation over the last 10 years or so, mainly for two reasons:

  1. Interest rates have been historically low and this has led to lower amounts of income offered.
  2. There is no legacy to pass on to your children.

Both of the above reasons still hold true today. But if your objectives are slightly different, perhaps you don’t have children, or you already have other assets to leave to your children, you might just want to at least consider a pension annuity.

Here’s why.

Consider a pension annuity – 5 benefits

#1 – An annuity pays you income

An obvious one but actually it may be more important to you than you think. Through my experience dealing with clients and helping them phase into retirement, one of the things people struggle to deal with most is the loss of the monthly wage. This helps you determine what you can afford to spend each month.

It’s easier when you know how much money you have coming into your bank account every month. It’s sometimes more tricky to get your head around deciding how much capital you should withdraw from your pension and hope that it doesn’t run out too soon.

#2 – An annuity can replace the low risk element of your investment portfolio

With most investment strategies it is important to be well diversified according to the level of risk that is appropriate for your objectives.

However, even the low risk element of your investment portfolio will still mean risk and the values can go up and down.

You could consider using a small part of your pension fund to purchase an annuity that is equivalent to the low risk element of your portfolio. Then you could invest the rest into medium and high risk investments knowing part of your portfolio is secure.

This handy calculator from Just shows you the probability of achieving your desired retirement income by replacing your low risk investments with an annuity.

#3 – No more fees

Once you purchase an annuity there are no more fees to pay to investment fund managers and perhaps even a Financial Adviser (if they charge a percentage of assets).

#4 – It can help your Inheritance Tax (IHT) strategy

By securing an income in the form of a pension annuity you may be able to utilise gifting (to avoid IHT) using an IHT allowance called ‘gifts out of surplus income’.

If you can prove you have more guaranteed income than you need, you can gift the excess away without paying IHT.

The same can’t be done if you use pension drawdown.

#5 – No further tests for Lifetime Allowance

The Lifetime Allowance tax charge applies when you start drawing an income from your pension and your total combined pensions are over the Lifetime Allowance (currently £1,030,000).

This test still happens when you purchase an annuity, the same as when you decide to use pension drawdown. However the key difference is that there are no further tests for a pension annuity.

A pension in drawdown will be tested again at age 75 and any growth since you started the drawdown will be subject to the charge.

Consider a pension annuity for the right circumstances

It is usually never a black and white answer as to whether a pension annuity or a pension in drawdown is best. It all depends on your individual circumstances and what you are trying to achieve. Most of the time a combination of the two can work quite well.

If you would like some support in building a tailored solution for your circumstances please get in touch for a no obligation first meeting at our expense. We would be delighted to help.

Risk warning:

Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.