How to maximise your retirement income: combining drawdown and annuities

As we approach retirement, many of us find ourselves standing at a financial crossroads, weighing up the best ways to ensure a steady income once we either reduce our hours or stop working completely.

Two options to consider for managing your retirement income could be drawdown and annuities. But have you thought about how you could combine these together to give you more flexibility?

What is an annuity? 

An annuity provides a steady stream of income in retirement, funded by using part or all of a pension pot. Once you’ve taken your tax-free lump sum, you hand the rest over to an insurance company in exchange for a guaranteed income payable for the rest of your life, known as a Lifetime Annuity.  

One drawback of a Lifetime Annuity is that you cannot normally change your mind once you’ve bought it. One alternative is a Fixed Term Annuity which can provide a guaranteed income for a set period, usually between three and 20 years, at the end of which you decide whether to buy a different type of annuity or take a variable income or lump sum from the amount returned to you.  

You can choose to build in other benefits when you buy, these include:

• An annual increase in the income you receive, at a set percentage or linked to inflation.
• A guarantee that in the event of your death, the income will continue to be paid out to your spouse for the rest of their life, at the same or a reduced level.
• Value or annuity protection, which allows you to protect all, or part of the fund used to buy your annuity.  You can opt for different amounts, whether that be 100% protection or 50% protection. If for example you opted for 100% protection, in the event of your death, the difference between the amount you paid for your annuity less the payments you’ve received will be repaid to your family. 

The rates on annuities can vary significantly between providers, as well as based on other factors such as interest rates, your health and age when purchasing the annuity. It’s crucial to shop around, we can help you to access a panel of annuity providers made up of companies we know and trust. It’s also vital to let the provider know if you have any health conditions, as this can result in a higher level of income through an Enhanced Annuity.

What is drawdown and how does it work? 

Drawdown refers to withdrawing money from your pension pot gradually. This allows you to leave your money invested and vary the amount of income you take to suit your circumstances. Because the money remains invested, it allows for potential investment growth while you enjoy your income. However, it’s worth noting, you may also lose if your investments don’t perform. There’s also the risk that you may exhaust the pot and run out of money later in life.     

Hybrid options: Combining drawdown and annuities

There are several strategies to blend drawdown and annuities to help enhance your retirement income effectively. 

1.      Fixed Term Annuity until state pension age

This option involves purchasing a Fixed Term Annuity that lasts until you reach your state pension age. You’ll receive guaranteed payments for this fixed period, normally between three and 20 years. The amount returned to you at the end will depend on the type of Fixed Term Annuity you buy – as some pay a fixed guaranteed amount while others are based on the performance of an underlying fund. 

It's also worth noting that if you’d like a guaranteed income and the flexibility to change your mind, it’s also possible to take a series of fixed term annuities that mature at different times.

It’s particularly beneficial for those looking for security in the initial years of retirement. Once you reach the end of your fixed term, you have the full range of pension income choices available to you once again. 

2.       Drawdown first and an annuity later in life 

Another possibility is entering retirement with drawdown first followed by an annuity later. This gives you flexibility as you can choose how much to take based on your lifestyle and financial situation initially. This can be especially beneficial during your early retirement years when you might want to travel, enjoy hobbies or spending time with family. By keeping your pension funds invested also gives it the potential to grow. However, it is worth noting that your investments can rise or fall and you my get back less than invested. 

As you move further into retirement, your priorities might shift, and this is where an annuity can play a crucial role in your financial plan. In delaying your annuity purchase, you can give yourself some more time to see if annuity rates improve, especially if your health changes as you get older. For example, if you currently have, or have had, health problems or a lifestyle which could affect your life expectancy, such as long-term smoking, you may be able to get a higher income. 

With increasing life expectancies, ensuring you don’t outlive your savings is important. Annuities can help alleviate this concern by guaranteeing income for a specified time period or even for the rest of your life.

3.     Combining drawdown and an annuity 

You can also consider a combination where you utilise both strategies concurrently. For example, you may opt for a smaller annuity for basic needs while using drawdown for any additional lifestyle expenses. You can adjust your withdrawals as needed, whether that be increasing, decreasing, stopping, or starting to suit your circumstances, while still enjoying any potential growth of your investments.

This strategy offers you the safety net of a guaranteed income alongside the flexibility of accessing your pension funds. 

Key Considerations: annuity, drawdown, or both? 

Choosing between an annuity, drawdown, or a combination of both depends on several factors.  

1.      Hands-on or hands-off?

Consider how involved you want to be. Drawdown works well if you're happy managing your pension, while annuities offer a more secure and maintenance-free approach.

2.      Flexibility vs. security

Do you prefer the freedom to adjust your income or the comfort of guaranteed payments? If you're comfortable with investment risk, drawdown might suit you. If security is your priority, an annuity could be better. 

3.      Health considerations

If you have health conditions, you might qualify for enhanced annuity rates. With drawdown, understanding your life expectancy could help ensure you manage your withdrawals, helping ensure your money lasts.

4.      Changing income needs

Think about your future spending. If your expenses might vary, drawdown gives you flexibility. For predictable spending, an annuity provides reliability. You could consider using annuities for essential costs and drawdown for everything else.

In summary, the combination of drawdown and annuities can be a powerful strategy for helping to maximise your retirement income. As you plan for this next phase, consider your lifestyle, income needs, and comfort with taking risks. 

Be sure to speak with your NFU Mutual Financial Adviser, who can offer personalised advice tailored to your circumstances and help you build a strategy that fits your retirement dreams.