Annuity vs drawdown: understanding your options at retirement

When you reach the point of taking money from a defined contribution pension, you face a decision that, until 2015, most people didn't really have. Before the pension freedoms came in, the default route was to buy an annuity. Today, you can take income flexibly through drawdown, buy an annuity, take ad-hoc lump sums, or — increasingly common — combine more than one approach. The question is no longer 'which one?' but 'what mix is right for me?'

What an annuity actually is

An annuity is an insurance product. You hand over a lump sum from your pension, and the insurance company commits to paying you a guaranteed income — usually for the rest of your life. The amount you receive each year depends on the 'annuity rate' the provider offers you, which is driven mostly by long-term gilt yields, your age, your health, and the options you choose (single life or joint, level or escalating, with or without a guarantee period).

Once it's set up, the income is fixed. It will keep coming for as long as you live (or, with an inflation-linked annuity, will rise each year). The trade-off is that the decision is irreversible: you can't normally cancel an annuity once it's in force, you can't change your mind if rates rise later, and once you die — unless you have a joint-life or guarantee period built in — payments stop.

What drawdown means

Drawdown — properly, 'flexi-access drawdown' — keeps your pension invested and lets you take income from it as and when you want. You decide how much to draw and when. The pot stays exposed to investment markets, so it can keep growing — but it can also fall, and if you draw heavily in poor markets early in retirement, the pot may not last as long as you'd hoped. This is sometimes called 'pound-cost ravaging' or 'sequence of returns risk'.

The value of investments and the income from them can fall as well as rise, and you may get back less than you invest. Past performance is not a reliable indicator of future results.

Drawdown also comes with more responsibility. Someone has to make decisions about how the pot is invested, how much to draw, when to rebalance, and whether the strategy is still appropriate as circumstances change. That's where ongoing advice tends to earn its keep.

How they compare on the things that matter

It helps to look at the trade-offs head-on:

• Income certainty: Annuity wins. You know what you'll get, every year, regardless of markets. Drawdown income is contingent on investment performance and how much you choose to take.
• Flexibility: Drawdown wins. You can vary your income year to year — drawing more for a one-off expense, less when you don't need it, taking nothing in years when you have other income.
• Inheritance: Drawdown wins, in most cases. Anything left in a drawdown pot can typically be passed on to beneficiaries, though tax treatment is changing — see below. With a level annuity, payments stop when you die.
• Inflation protection: Both can offer it, but at a cost. An inflation-linked annuity starts at a much lower level than a level one, and drawdown is only inflation-protected if your investments keep up.
• Investment risk: Annuity removes it; drawdown keeps it.
• Longevity risk: Annuity removes it (you can't outlive the income); drawdown keeps it (you can run out if you live longer than expected and draw too much).
• Cost: Annuities are not directly priced for fees, but the rate the provider offers reflects their margin. Drawdown carries explicit platform charges, fund charges, and (usually) advice fees.

Why annuity rates have changed the picture

For most of the 2010s, low interest rates made annuities look unattractive. That has changed. Higher gilt yields since 2022 have lifted annuity rates substantially, and the 2025/26 environment offers some of the best annuity rates seen in over a decade. We've written a separate piece on why the current environment is favourable, and why some clients are choosing to lock in income now rather than waiting.

It's worth noting that annuity rates are not guaranteed to stay where they are. They move with gilt yields, which in turn move with interest rates and inflation expectations. That uncertainty cuts both ways: rates may rise further, or they may fall.

The 'flex then fix' approach

Many of our clients don't choose between annuity and drawdown — they use both, in sequence or in parallel. A common pattern is to use drawdown in the early years of retirement, when you might want flexibility, you're more able to ride out market falls, and you may be doing big-ticket spending (travel, helping children, replacing a car). Then, in later retirement — typically your 70s — to use part of the remaining pot to buy an annuity. By that age, annuity rates are higher, you have a clearer view of what your essential income needs are, and you may value the certainty more.

Another approach is to layer income. Use an annuity to cover essential expenses (food, bills, council tax) so those are guaranteed for life. Keep the rest in drawdown to fund discretionary spending — holidays, gifts to family, occasional treats — where flexibility is more useful and a fall in income would be uncomfortable but not catastrophic.

The Inheritance Tax change to be aware of

From 6 April 2027, unused defined contribution pensions are due to come within the scope of Inheritance Tax for the first time. Until then, most pensions can pass to beneficiaries free of IHT. The change has prompted some clients to reconsider how much of their wealth they hold in pensions versus elsewhere, and to think more carefully about how income is structured. Annuity income is paid for life and has no residual pension pot to be taxed at death — which, depending on your circumstances, may shift the calculus. Tax treatment depends on individual circumstances and may be subject to change in future.

How we think about it with clients

There's no single right answer. The right mix for you depends on the level of certain income you need, the risk you're willing to take with the rest, what you'd like to leave behind, your health, and how long you might reasonably expect retirement to last. Cashflow modelling helps test different combinations against your real circumstances — including poor market scenarios — so the choice isn't made on a hunch.