If you have a defined contribution pension, one of the biggest decisions you will make is how to turn it into an income. The two main options are buying an annuity or keeping your money invested and using drawdown. Each has real strengths, and for many people the best answer is a bit of both.
Here is a plain-English comparison to help you work out which suits you.
Quick answer: An annuity swaps some or all of your pension for a guaranteed income, usually for life. Drawdown keeps your pension invested so you can take money as and when you need it. Annuities give certainty but are usually permanent. Drawdown gives flexibility but your money can run out or fall in value. Many retirees combine them: an annuity to cover essential bills, drawdown for the rest.
In this guide
- What an annuity is
- What drawdown is
- Side-by-side comparison
- Who an annuity tends to suit
- Who drawdown tends to suit
- Mixing the two
- Tax and inheritance points
- How to decide
What is an annuity?
An annuity is a product you buy from an insurance company with some or all of your pension. In return, it pays you a guaranteed, taxable income, either for the rest of your life (a lifetime annuity) or for a fixed number of years (a fixed-term annuity).
How much you get depends on how much you convert, your age, your health, current interest rates and the features you choose. As a simple illustration, converting a £100,000 pot at an annuity rate of 5% would give you £5,000 a year, and at 6%, £6,000 a year.
Features you can choose include:
- Level or increasing income. A level annuity pays more at the start. An increasing one rises each year by a set rate or with inflation, which protects you against rising prices.
- Joint life. Your partner continues to receive part of the income after you die.
- Guarantee period or value protection. Your beneficiaries get something back if you die early.
- Enhanced annuity. If you have health conditions such as diabetes or high blood pressure, or you smoke, you could get a higher income.
Each extra feature usually lowers the starting income. Most annuities have a 30-day cooling-off period, but after that you normally cannot change your mind.
What is drawdown?
With drawdown, you usually take up to 25% of your pension tax-free and leave the rest invested. You then take money out whenever you like, either as a regular income or as one-off amounts. Anything you take beyond the tax-free part is taxed as income.
Because the money stays invested, it can keep growing, but it can also fall in value. If you take out too much, or markets fall early in your retirement, your pot could run out while you still need it.
Annuity vs drawdown: side by side
| Annuity | Drawdown | |
|---|---|---|
| Income | Guaranteed, usually for life | Flexible, but not guaranteed |
| Investment risk | None once bought | Your pot can rise or fall |
| Flexibility | Usually fixed once set up | Change or stop withdrawals at any time |
| Risk of running out | None with a lifetime annuity | Possible if you take too much |
| Inflation | Protected only if you choose an increasing annuity | Depends on investment growth |
| Leaving money to family | Only with joint life or guarantees | What is left can usually be passed on |
| Effort | Low, set and forget | Needs regular reviews |
| Charges | Built into the rate | Ongoing platform and fund charges |
Who does an annuity tend to suit?
- People who want certainty and do not want to worry about the stock market
- People who need a reliable income to cover essential bills
- People in poorer health, who may qualify for an enhanced rate
- Older retirees, as rates are usually higher the older you are
- Anyone who does not want to manage investments
Who does drawdown tend to suit?
- People with other secure income, such as a final salary pension or the full State Pension, who can afford some ups and downs
- People who want flexibility, for example to take more in their early, active years
- People who want to leave money to family
- People comfortable with investing, or willing to pay for advice
- People who are still working part-time and want to take money only occasionally
Mixing the two
You do not have to choose one or the other. Many people:
- work out their essential monthly spending (housing, food, bills, insurance)
- see how much of that the State Pension already covers
- use part of their pension to buy an annuity that covers the gap
- keep the rest in drawdown for holidays, gifts, home improvements and emergencies
You can also start with drawdown and buy an annuity later. Annuity rates usually improve as you get older, and your health may qualify you for an enhanced rate. If you have several pensions, you can treat each one differently. If you have lost track of an old pot, see our guide to finding a lost pension from an old job.
Tax and inheritance points to know
- Tax-free cash. You can usually take up to 25% of your pension tax-free, within the lump sum allowance of £268,275 for most people. You do not have to take it all at once. See our guide to UFPLS and pension tax-free cash.
- Income tax. Annuity income and taxable drawdown withdrawals are added to your other income, including your State Pension. Read how the State Pension is taxed to see how this can push you into paying tax.
- The money purchase annual allowance. Once you take taxable money from drawdown, or buy a fixed-term annuity, the amount you can pay into pensions with tax relief usually drops from £60,000 to £10,000 a year. Buying a lifetime annuity does not trigger this.
- Inheritance tax from April 2027. Unused pension funds are due to count towards your estate for inheritance tax. This may make drawdown less attractive as a way to pass on wealth. See what the pension inheritance tax change means for you.
- Emergency tax. Providers sometimes use an emergency tax code on your first payment. If you have overpaid, you can claim it back.
How to decide
- Book a free Pension Wise appointment. If you are 50 or over with a defined contribution pension, MoneyHelper offers free, impartial guidance on your options.
- Shop around. If you are buying an annuity, compare quotes rather than just accepting your provider’s offer. The difference between providers can be significant. Check first whether your pension has a valuable guaranteed annuity rate.
- Be honest about your health. Answering the medical questions fully can boost an annuity offer.
- Consider advice. A regulated financial adviser can recommend what to do, which is especially useful for larger pots. See our guide to getting financial advice for retirement.
- Never act on a cold call. Unexpected calls, texts or emails about your pension are very likely to be scams. Read our guide to avoiding scams in retirement.
Frequently asked questions
Can I swap from an annuity to drawdown later?
Usually not. Once the cooling-off period ends, most annuities cannot be cancelled. But you can move from drawdown to an annuity at any time.
How much can I safely take from drawdown?
There is no single safe figure. It depends on your pot size, investments, other income and how long you need the money to last. Some people use around 4% a year as a rough starting point, but it is not a guarantee, and regular reviews matter more than any rule of thumb.
Do I have to decide when I stop work?
No. You can leave your pension invested and decide later. Just check how it is invested as you approach retirement, because many schemes move your money into lower-risk funds automatically.
What if I only have a small pension?
If your pot is small, taking it as a lump sum may be simplest. Our guide on whether to take your pension as a lump sum or regular income explains the trade-offs.
Final thoughts
An annuity buys you peace of mind, while drawdown buys you flexibility. Neither is right for everyone. Start by working out what income you need to feel secure, look at what the State Pension and any other guaranteed income already cover, and then decide how much of your pension needs to be guaranteed.
For the bigger picture, read our guide to what to do with your pension pot when you retire and our tips on protecting your pension from inflation.
