The decision most people are unprepared for
You spend decades building up a pension pot. Then, at some point in your late 50s or 60s, you face the most significant financial decision you will likely ever make: how to turn that pot into an income for the rest of your life.
In recent years, the majority of people have chosen pension drawdown - keeping their money invested and taking flexible withdrawals as needed. Annuities, which trade a lump sum for a guaranteed income for life, fell sharply out of favour when interest rates were near zero. But the landscape has changed significantly. Annuity rates have improved substantially, the April 2027 pension inheritance tax changes have introduced a new variable into the decision, and many people who chose drawdown five years ago are now revisiting whether that remains the right approach.
How drawdown works
With pension drawdown (officially called "flexi-access drawdown"), you keep your pension invested and withdraw money as and when you need it. There is no fixed income - you decide how much to take and when, subject to your tax position.
The main advantages are flexibility and the potential for continued investment growth. If you die with money still in drawdown, the remaining funds can typically pass to your beneficiaries - though from April 2027, this could now attract inheritance tax.
The risks are the mirror image of the advantages: you could withdraw too much too quickly, your investments could fall in value at the wrong time (known as "sequence of returns risk"), or you could simply live longer than expected and run out of money. These are not theoretical concerns - they are the central planning challenge of retirement.
Important: Once you start drawing actual income from a flexi-access drawdown fund, the Money Purchase Annual Allowance (MPAA) drops to just £10,000. This severely limits how much you can contribute back into a pension if you return to work or want to continue saving. Importantly, taking only the tax-free cash (PCLS) and placing the remainder into drawdown without yet drawing income does not trigger the MPAA - it is the act of drawing flexible income that matters, not the designation to drawdown. Many people trigger this limit without realising it. Understanding the MPAA before you access your pension is essential.
How an annuity works
An annuity is a contract with an insurance company: you hand over a lump sum (typically from your pension pot) and in return receive a guaranteed income for life, regardless of how long you live or what happens to investment markets.
Annuities come in several forms - level (fixed income), inflation-linked (increasing annually with RPI or CPI), and enhanced (paying a higher rate if you have certain health conditions). You can also purchase joint-life annuities that continue to pay a reduced income to your spouse after your death.
The main disadvantage is irreversibility. Once you buy an annuity, the decision is final. If you die shortly after purchasing, your estate typically receives nothing beyond any agreed guarantee period.
Annuity rates in 2025/26 - the case for reconsidering
For much of the 2010s, annuity rates were so poor that the decision felt straightforward for most people. A £100,000 pension pot might have bought an annual income of £4,000-£4,500. It was hard to make that work.
That has changed. Current annuity rates for a 65-year-old are broadly in the region of £7,000-£7,700 per year per £100,000 on a level, single-life basis (figures are indicative - commercial rates vary by provider and change over time). Enhanced rates for someone with common conditions (type 2 diabetes, high blood pressure, a history of smoking) can be meaningfully higher.
These rates reflect the higher interest rate environment that has persisted since 2022-23. They do not guarantee that rates will stay at these levels, but the improvement makes annuities a genuinely competitive option in a way they were not five years ago.
How the April 2027 pension IHT change affects this decision
Before October 2024, one significant argument for keeping money in drawdown was that unspent pension funds could pass to beneficiaries outside the estate - making a drawdown pension one of the most tax-efficient inheritance vehicles available.
From April 2027, that advantage largely disappears. Unused pension funds will be subject to inheritance tax at 40% above the available nil-rate band, just like other estate assets. This removes a significant argument against annuities for those who were keeping money in drawdown primarily for inheritance tax purposes.
An annuity, by contrast, dies with you (or your spouse if a joint-life policy). There is no residual value left in your estate, which means no IHT on the annuity itself. For some people, this now makes the comparison considerably closer than it would have been before the rule change.
Can you have both?
Yes. A blended approach - using an annuity to cover essential fixed costs and drawdown for discretionary spending and flexibility - is one of the most sensible strategies available and is widely used by people with larger pension pots. The guaranteed income from the annuity provides a floor of security; the drawdown pot provides flexibility and potential growth. This approach also limits the downside if investment markets perform poorly, and reduces the risk of running out of money in later life.
Questions that help clarify the decision
- Do you have other guaranteed income? If you have a final salary pension or significant other income, you may already have your essential costs covered. In that case, keeping your DC pension in drawdown for flexibility makes more sense.
- How important is flexibility to you? Drawdown suits people who value the ability to vary their withdrawals - for large one-off purchases, care costs, or passing on wealth. Annuities suit people who value certainty and do not want to manage investments in retirement.
- What is your health? Poor health is, counterintuitively, an argument in favour of an annuity - you will likely qualify for an enhanced rate, and the guaranteed income protects against the risk of unexpectedly prolonged ill health requiring care.
- What are your plans for the money you don't spend? With the April 2027 IHT changes, the argument for keeping money in drawdown purely as an inheritance vehicle is considerably weaker. If passing wealth to your children is a priority, there are now better ways to structure this.
- Are you worried about running out of money? If the thought of outliving your savings is a genuine concern - and for most people it should be, given that 1 in 4 women reaching 65 today will live to 92 - the security of a guaranteed income is not just convenient, it is psychologically important.
There is no universally correct answer
The drawdown vs annuity question cannot be answered in isolation. The right approach depends on the size of your pension, your other income and assets, your tax position, your health, your family situation, and what you are actually trying to achieve in retirement. The answer for a 63-year-old in good health with a £600,000 pot and a final salary pension is likely very different from the answer for a 67-year-old with £150,000 and no other income.
What is consistent is that this decision benefits enormously from proper independent advice. The stakes are high, the decision is largely irreversible in the case of annuities, and the interaction with tax rules - income tax, IHT, the MPAA - is complex enough that getting it wrong has lasting consequences.