Annuities vs drawdown – Which is right for you?

For those approaching retirement, thoughts are undoubtedly turning to how to secure the right kind of income. Since the pension freedoms came into force in April 2015 you can still purchase an annuity should you wish, but the rules around income drawdown have been relaxed. But, which one is right for you? It's a wholly personal decision, but we've broken a few things down to help clear the minefield.

* This table does not constitute financial advice. It gives an overview of the different options available to you. If you have any doubt, you should seek independent financial advice.

An annuity is a specially-designed product that can secure an income in retirement. It's purchased when you retire by using the money built up in your pension and will provide a guaranteed regular income every month for life, thereby helping you maintain a decent lifestyle in retirement.

While an annuity can provide you with a guaranteed income for life, it's just that – for life. That means whether you live for another five years or another 50 you'll get your income, but the downside is that if you died after five years, your annuity provider would get to keep the rest of your pension pot (unless this was during a guarantee period or you set up Value Protection). On the other hand, if you lived for another 50 years, you'd probably be on to a winner as the annuity provider would be paying out money they didn't expect to.

Income drawdown could also be an option for you thanks to the increased flexibility. The rules mean that you can keep your pension invested and withdraw a certain amount from your pot on a regular basis rather than having to opt for an annuity. The income you take will be taxed in the same way as employment income.

A key benefit is that, when you die, your estate will benefit from any remaining money from your pension pot, unlike with an annuity where any unused funds can be lost if don't choose the right options at outset. There may be a tax liability for your beneficiaries depending on what age you are when you die, but there'll still be money to pass on.

Find out more about how pension drawdown works.

However, there are some crucial risks with not buying an annuity and leaving your pension invested. Firstly, as your pension remains invested, there is a risk that your pot could decrease if the funds you've invested in don't perform well – and at a time of life when you may not be in a position to replace your losses with new money.

Then there's the risk that you could literally empty your pension pot if you withdraw too much, leaving you with a much reduced income in later years.

The reasons for and against buying an annuity are complex, so we've created the table above to summarise the main differences. Everybody's situation is unique, so this table is not designed to give advice, but to help you come to an informed decision.

As with so many financial decisions, there's no easy answer. The 'Catch 22' is that an annuity becomes better value the longer you live, but over a shorter term will not pay you, or your estate, as much income. The choice you make will depend on what you conceive your pension as being for: is it to provide you with income in your retirement, to provide a financial legacy for your family, or a combination? That decision comes entirely down to your own individual circumstances and preferences, but thanks to the new rules, at least now there are more options.