Why Choose Between Annuity and Drawdown When You Can Have Both?
Since the pension freedoms of 2015, retirees have faced a stark choice: buy an annuity for guaranteed lifetime income, or use drawdown for maximum flexibility. But this binary framing overlooks what many financial advisers consider the optimal approach for most people — using a combination of both.
A partial annuity strategy involves using part of your pension pot to buy an annuity that covers your essential fixed expenses, while keeping the remainder in drawdown for discretionary spending, investment growth, and inheritance planning. This blended approach captures the best features of both options while mitigating their respective weaknesses.
How the Partial Annuity Strategy Works
The core principle is straightforward: calculate your essential fixed costs, subtract any guaranteed income you already have (State Pension, defined benefit pensions), and use enough of your pension pot to buy an annuity that covers the remaining shortfall. Everything left over stays in drawdown.
Step-by-step example
Consider a 65-year-old with a £300,000 pension pot and the full State Pension:
- Essential annual expenses: £18,000 (housing, bills, food, insurance, council tax)
- State Pension income: £11,975 per year
- Shortfall to cover: £6,025 per year
- Annuity cost: Approximately £90,000 to generate £6,025 per year (at current rates for age 65)
- Remaining in drawdown: £210,000 for discretionary spending, holidays, gifts, and growth
Finding the Right Split
| Pot Size | Essential Shortfall | Annuity Portion | Drawdown Portion | Split Ratio |
|---|---|---|---|---|
| £150,000 | £4,000/yr | ~£60,000 | ~£90,000 | 40/60 |
| £200,000 | £5,000/yr | ~£75,000 | ~£125,000 | 38/62 |
| £300,000 | £6,000/yr | ~£90,000 | ~£210,000 | 30/70 |
| £500,000 | £6,000/yr | ~£90,000 | ~£410,000 | 18/82 |
Based on a 65-year-old with full State Pension. Shortfall represents essential expenses minus State Pension.
Benefits of the Partial Annuity Approach
Guaranteed income floor
Your essential bills are covered regardless of what happens to markets. Even if your drawdown investments fall significantly, your lights stay on, your mortgage gets paid, and food stays on the table. This security is the single most important benefit of the strategy.
Flexibility for discretionary spending
The drawdown portion gives you the freedom to vary withdrawals based on need. Take more in years when you are active and want to travel, less in quieter years. This flexibility is impossible with an annuity alone.
Investment growth potential
Money in drawdown remains invested and has the potential to grow, potentially providing more income than if the entire pot had been annuitised. Over a 20-30 year retirement, even modest growth can significantly increase your total income.
Better inheritance planning
The drawdown portion can be passed to beneficiaries on death, subject to income tax. With a full annuity, the remaining capital is typically lost (unless you have selected death benefit features). A partial annuity preserves a substantial fund for your family.
Tax-Free Cash Considerations
You can take 25% tax-free cash from the portion used for the annuity as a pension commencement lump sum. You also retain the ability to take 25% tax-free from drawdown withdrawals (if using uncrystallised funds pension lump sums) or take a separate tax-free lump sum when designating funds for drawdown.
Careful structuring can maximise your tax-free entitlement. For example, you might take 25% of the annuity portion as tax-free cash up front, and use UFPLS withdrawals from the drawdown portion where each withdrawal is 25% tax-free.
When to Consider a Partial Annuity
- Pot size £100,000+: Smaller pots may not generate meaningful annuity income and are better in drawdown or taken as cash
- You value security for essentials: If sleeping soundly knowing your bills are covered matters to you
- You want some flexibility: Pure annuity is too rigid, pure drawdown is too risky
- You have a partner: The annuity can provide joint-life protection while drawdown offers inheritance for children
- You are approaching or past State Pension age: Your other guaranteed income is established, making it easier to calculate the shortfall
Phased Partial Annuity: The Advanced Strategy
Rather than implementing the strategy in one go, many people build their annuity floor over time:
- Age 60-65: Start drawdown only, using pension for income alongside any other earnings
- Age 66-67: State Pension begins, reassess essential expenses gap
- Age 67-70: Buy a partial annuity to cover remaining essential shortfall
- Age 75+: Consider buying additional annuity income if drawdown pot allows and health qualifies for enhanced rates
Comparing the Three Main Approaches
| Feature | Full Annuity | Partial Annuity | Full Drawdown |
|---|---|---|---|
| Income security | Maximum | High for essentials | None guaranteed |
| Flexibility | None | Moderate | Maximum |
| Growth potential | None | On drawdown portion | On entire pot |
| Inheritance | Limited | Drawdown portion passes on | Entire pot can pass on |
| Risk of running out | None | Low (essentials covered) | Significant |
| Complexity | Simple | Moderate | Higher |
Next Steps
A partial annuity strategy requires careful planning to get the split right. Consider your essential expenses, existing guaranteed income, risk tolerance, and family circumstances. A qualified pension adviser can model different scenarios and help you find the optimal balance between security and flexibility for your retirement.