Annuities and drawdown are the 2 primary methods of utilizing your pension pot to fund your retirement. However how are they completely different? What possibility is greatest for you? And what dangers do you want to concentrate on?
Our Cash weblog group has put collectively a information explaining every thing you could know concerning the two choices.
First, let’s have a look…
DRAWDOWN
It is a approach of managing the way you spend your pension pot – and is a way more versatile approach of accessing your pension than its primary various, the annuity.
It means that you can take sums out progressively whereas leaving the remainder invested.
Pension suppliers and funding platforms supply the product, which is mostly obtainable to folks aged 55 and over (rising to 57 from 2028) with an outlined contribution pension, and never closing wage or outlined profit pensions.
How does it work?
You often begin by taking as much as 25% of your pension pot tax-free.
The remaining is moved into what’s known as a “drawdown account”, the place it stays invested in funds of your selecting, akin to shares or bonds.
You may take revenue from that invested pot everytime you like – however something you withdraw past the tax-free portion (25%) is taxed at your revenue tax price.
The danger
You’ve got full management over how a lot to withdraw and the way usually, making it versatile for altering revenue wants – which sounds superb.
Nevertheless, as a result of your pot stays invested, it will possibly rise or fall relying on market efficiency.
Poor funding returns or withdrawing an excessive amount of too quickly might imply your cash runs out in retirement. It could possibly take only one risky world occasion, akin to Donald Trump imposing tariffs, to wipe important worth out of your fund.
You additionally have to be sure to take accountability for the drawdown – keeping track of the way it’s performing, when to take out lump sums and so on.
For those who do not plan correctly and run out of cash, that is on you.
ANNUITIES
This monetary contract converts your financial savings into an annual revenue, like a state pension, slightly than versatile drawdowns.
The product is bought by insurance coverage corporations to these aged 55 and over and could be fixed-term or lifetime.
Funds are made both yearly, biannually, quarterly or month-to-month, and the way a lot you obtain is dependent upon the scale of your pension financial savings, the options of your specific annuity, and your well being and life-style.
How does it work?
The annuity fee is an annual proportion of the quantity you change. So for those who spend £100,000 of your pension financial savings on an annuity product at a 5% price, you will get £5,000 a 12 months.
As soon as you have agreed to the contract, you can not change your annuity, take out lump sums, or switch it to another person.
There are several types of annuity…
Fastened v lifetime
Lifetime annuities assure you a set revenue for the remainder of your life, irrespective of how lengthy that’s.
Fastened-term or short-term annuities pay an revenue for a set time period, usually between three and 25 years.
This lets you store round for different choices as soon as the contract ends. Some folks would possibly use them as a bridge between retirement and the start of their state pension at age 66.
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What charges can be found
There are numerous packages, so let’s begin with the only. Degree annuities pay out the identical sum of money every year however they’re susceptible to inflation, which may scale back your lifestyle over time.
Escalating annuities present a partial resolution to this drawback, growing at a set proportion every year (eg 3%). The catch is that funds start at a decrease price than stage annuities.
Inflation-linked annuities rise in step with the retail worth index (RPI), proofing your revenue in opposition to inflation, however beginning at a a lot decrease price.
Funding-linked annuities make investments a part of your pension fund and pay out additional revenue – or not – based mostly on the efficiency of the funding.
Impaired or enhanced annuities can be utilized if in case you have well being points which are anticipated to shorten your lifespan. This permits bigger annual funds to be made on the premise that insurance coverage corporations count on to unfold them over a shorter time period.
Joint life annuities can help you pay your partner or associate after your demise, however usually at a decrease price. Or you may shield a lump sum in your preliminary settlement to be transferred to your beloved while you cross away.
Taxation
Annuities contribute to your private allowance and, as soon as that’s reached, are taxable like another revenue stream. Keep in mind, you’re entitled to attract down a 25% lump sum tax-free out of your pension pot.
An annuity paid to a partner or associate after your demise can be topic to revenue tax, except you die earlier than the age of 75.
Benefits and downsides
In abstract, listed here are the positives and negatives to contemplate.
Variations between drawdown and annuity
Listed here are the principle variations between the 2:
Drawdown: Versatile entry, funding progress potential, however no assured incomeAnnuity: Fastened, assured revenue for all times or a set interval, however no flexibility or progress potential as soon as bought
Are you able to combine the 2?
Sure – in actual fact, the variety of folks doing that is rising.
You may break up your pension pot – shopping for an annuity with one half and utilizing drawdown with the opposite.
This hybrid strategy helps stability regular and safe revenue with the prospect of progress with the opposite – in addition to management over your remaining funds.
