Buying an annuity after drawdown

If you are already taking an income from drawdown, the money left in that pot is not locked into it. You can use what is left of your drawdown pot to buy an annuity, at any time, and you do not have to buy it from the provider that runs your drawdown plan¹. The annuity is bought from an insurance company and pays a regular income for life³.

The decision is one way. Once you buy an annuity there is no turning back: you cannot cancel or alter the terms, or transfer to a drawdown plan⁴. You also cannot change your mind during a cooling-off period in the way you can with many financial products⁵. That is why the shopping-around step matters more here than almost anywhere else in retirement planning.

You can also split the difference. It is possible to use some of your pension to buy an annuity and put the rest into drawdown, and you can buy an annuity with only part of the pot⁴. A short-term or fixed-term annuity can be bought with part of your pension pot to provide income for a set period⁶.

Drawdown or annuity: how income, risk and charges compare

These are the two main ways to turn a defined contribution pot into an income, alongside taking lump sums or the whole pot at once⁹. They behave very differently.

An annuity pays a fixed income for the rest of your life¹⁰. Drawdown has no such guarantee: it is a higher risk option than an annuity, because the stock market can go up or down and you could end up with far less income than planned¹¹. That risk cuts both ways, since a pot left invested can also grow, but the income is not secured.

The charges differ in shape. Drawdown carries ongoing platform and fund costs, and providers also charge for withdrawals. One provider charges no drawdown fees unless a full withdrawal is made within a year of the first transfer¹³. For a drawdown pot worth £350,000, the average value among drawdown customers surveyed, annual fees vary from around £1,000¹⁴. An annuity has no ongoing investment charge because there is no invested pot left to manage, but the income is fixed at the point of purchase and the capital is gone.

Shopping around: annuity rates vary by provider and by your health

Different annuity providers offer different rates and options, and shopping around can help you find the annuity that is best suited to your circumstances, or the one that pays the highest income¹⁶. The same applies to drawdown itself: some providers do not offer income drawdown at all, so it is worth checking what your provider actually provides³.

What drives the income you are offered is your health and lifestyle, annuity rates in the market, and your age when you buy it¹⁷. Health and lifestyle can work in your favour: depending on your health and lifestyle, you may be able to get a higher rate¹⁸. Impaired or enhanced annuities pay out a higher income if your health or lifestyle may shorten your lifespan, and they are aimed at people with existing health conditions, smokers and people who are overweight⁶. Drawdown offers no equivalent uplift⁴.

You also choose how the income behaves. When buying an annuity, you can choose whether the level of payment will stay the same, rise with inflation, or drop off later¹⁹. Each choice changes the starting income, so the highest opening figure is not automatically the right structure.

What happens to your pension when you die

Death benefits are where drawdown and annuities diverge most sharply, and where the choice can matter more than the income itself.

With drawdown, if you die before 75 your beneficiaries can access any money remaining in your drawdown plan tax-free²⁰. If you die when you are 75 or over, your beneficiaries will have to pay income tax on any income they take from your drawdown plan²¹. More precisely, if the individual dies before age 75, death benefits including lump sums and inherited drawdown pensions are typically taken free of Income Tax; if they die on or after age 75, these benefits are usually taxed as income at the recipient's marginal rate²². Your beneficiary or beneficiaries will be able to choose how they take the money, either as a lump sum, continue in drawdown or buy an annuity²³.

An annuity works differently. Income from annuities will not be subject to inheritance tax, for both single-life and joint-life annuities²⁴. But the capital has left your estate in a different sense: a single-life annuity normally stops when you die, and a joint-life annuity continues to a named person only. Money left in a pension or drawdown plan when you die is currently exempt from inheritance tax, though that is set to change²⁰.

Once bought, an annuity cannot be reversed

This is the single most important difference between the two options, and it is worth stating plainly. Once you buy annuity, the decision cannot be unwound: you will not be able to alter your level of income or switch to another provider²⁶. Once you have bought an annuity, you cannot change your mind⁵. You cannot cancel or alter the terms, or transfer to a drawdown plan⁴. You cannot usually change your mind once you have bought an annuity³.

Drawdown is the opposite. If you go into drawdown to start with, you can change this and buy an annuity later, perhaps once you are older if that suits you better¹⁵. That reversibility is the main argument for starting in drawdown and deciding later, provided you accept the investment risk in the meantime.

There is one narrow exception in the rules on cancellation. A firm need not accept notification of cancellation of a pension annuity contract if the life, or any of the lives, assured under it has died before notice is given²⁷. In practice this means the cancellation right does not survive the death of the person the annuity was written on.

A drawdown pot stays flexible until the moment an annuity is bought.

Tax on annuity income and death benefits

Annuity income is taxable. Like drawdown, you will pay tax on the annuity income²⁸. It is paid gross and taxed as pension income through the normal income tax system, so the rate depends on your total income in the year.

The tax-free cash position is settled before the annuity is bought. A quarter (25%) of your pension pot can usually be taken tax-free before you buy the annuity, and any other payments will be taxed⁸. That is subject to your remaining lump sum allowance²⁹. If you take tax-free cash, you cannot add it back later to boost your annuity payments³⁰. So a decision to take cash early reduces the pot that funds the income, permanently.

On death, the treatment depends on when you die rather than on which product you hold. If the individual dies before age 75, death benefits including lump sums and inherited drawdown pensions are typically taken free of Income Tax; if they die on or after age 75, these benefits are usually taxed as income at the recipient's marginal rate²². Both lump sum withdrawals and regular income, taken through income drawdown or an annuity, will be taxed at your beneficiary's marginal rate of income tax where death occurs after the 75th birthday³¹.

Combining pots and moving money across

It is possible to combine all existing pension savings to buy one annuity, which is likely to attract a higher income than buying lots of individual ones³². You can choose which pensions you want to combine and which you would like to keep separate, so you do not have to consolidate them all³³.

Before doing that, check what leaving your current arrangement costs. With flexi-access drawdown, you will pay a fee to your pension provider for each withdrawal, and a full withdrawal to fund an annuity may count as one². Those charges come out of the pot before it is converted, so they reduce the income the annuity can buy.

Where to get free help

Pension Wise provides free guidance on adjustable income and the other ways to take a pension⁷. MoneyHelper and the Pensions Ombudsman are also available if something goes wrong with a provider or an adviser. The FSCS publishes guidance on what it protects, including whether FSCS protects financial advice, what happens if a firm gives bad advice and fails, and whether advised products are FSCS protected if the provider fails³⁴. If you are considering moving a defined benefit pension rather than a drawdown pot, different rules apply and the FCA publishes consumer guidance on defined contribution pension transfers³⁵.