Annuities vs. Pension Drawdown: Which is right for your client?

The role of a financial adviser is more than where to put your money, crucially it’s guidance. Helping to guide clients through their retirement and supporting them in their decisions.

Annuities and pension drawdown are two popular choices for generating retirement income and each has its own set of advantages and disadvantages. The best choice really comes down to your clients’ individual financial goals and their attitude and tolerance to risk.

In this article we take it "back to basics" to compare the two and help advisers understand these options better. Whether you’re new to the role or just moving fields.

What is an annuity?

An annuity is a financial product that provides a guaranteed income for life or a specified period in exchange for a lump sum payment. This can offer peace of mind for those retirees who would prefer a predictable income stream.

Pros of annuities

• Guaranteed Income - Provides a steady and predictable income for life.
• Simplicity - There is no management required after set up.
• Longevity protection - Safeguards against outliving savings.

Cons of Annuities:

• Inflexibility - Terms can’t be changed after purchase.
• Potentially Lower Returns - Annuities might offer lower returns compared to some other retirement products.
• Costs - In some cases they can include high fees and surrender charges.

What is Pension Drawdown?

Pension drawdown allows retirees to withdraw money from their pension pot while keeping the remaining funds invested. This option offers more flexibility but comes with its own risks.

Pros of Pension Drawdown:

• Flexibility - Retirees can adjust their income according to their needs.
• Growth potential - Remaining funds stay invested, potentially increasing in value.
• Control - Retirees manage their investment choices and withdrawal amounts.

Cons of Pension Drawdown:

• Investment Risk - The value of investments can fall as well as rise.
• Complexity - Requires ongoing management and monitoring.
• Sustainability Risk - High withdrawals may not be sustainable over the long term.

Choosing the Right Option

When advising clients on whether to choose an annuity or pension drawdown, consider the following factors:

1. What are their financial goals? Determine if the client prioritises a guaranteed income (annuity) or prefers the flexibility and potential growth of investments (drawdown).
2. What is their attitude to risk? Assess the client's comfort with investment risk. Annuities offer security, while drawdown involves market exposure.
3. What are their health concerns? Longevity is a factor. For clients with health issues or shorter life expectancy, an annuity might not be as beneficial. Conversely, those expecting a longer retirement might benefit more from the guaranteed income of an annuity.
4. What are their income needs? Evaluate the client's income requirements. If they need a flexible income that can adapt to changing circumstances, drawdown might be more suitable.

Both annuities and pension drawdown have their place in retirement planning. The key is to understand the client's unique situation and preferences. By weighing the pros and cons of each option, advisers can help retirees make informed decisions that align with their financial goals and risk tolerance.