Pension Withdrawal Options: Lump Sums vs Annuities

According to official figures, 609,563 people reached pensionable age in 2021, a significant jump from the 2020 figure of 341,026. However, you don’t have to wait until you reach the official state pension age to retire. If you have a private or workplace pension, it’s possible to start withdrawing money when you turn 55. It’s important to understand the options available to you so, if you’re not yet 55, it’s worth consulting a pension planning specialist.  

The withdrawal options 

It’s a good idea to speak to an adviser experienced in annuities and lump sums before you make a decision. It isn’t always possible to change an option after you’ve selected it.  

Annuities
The rules on annuities changed in 2015, when it became possible to take a tax-free lump sum of up to 25% of your pension value, and purchase an annuity with the rest. The simplest way to understand an annuity is that it’s a contract between you and an insurance company of your choosing. You pay the insurance company an agreed sum of money and they provide you with an agreed income for the rest of your life. In some cases, this is for a predetermined number of years.  

Lump sums
An alternative way to access your pension funds is to simply withdraw either the whole amount or part of it as a lump sum. The first 25% is tax-free but you’ll be taxed on the remainder. If you withdraw the rest in subsequent years, the first 25% of each withdrawal will be taxed. It’s up to you what you do with the money you withdraw.  

Considerations when choosing lump sums vs annuities 

Before you make a decision, it’s important to understand the advantages and disadvantages of each withdrawal option: 

Annuities
The most obvious benefit of an annuity is that you’re guaranteed to receive the agreed amount from the insurance company every month for the rest of your life (or for the agreed period). Many of our clients choose this option as it offers them financial security and peace of mind. 

However, it’s important to be aware that the amount of annuity you’ll be paid will depend on several factors. Age and expected life expectancy play a part, as does your medical history, the amount you have available to purchase an annuity, and crucially, the prevailing interest rates at the time of your pension drawdown. Interest rates fluctuate and it’s impossible to say what it will be when you retire. For this reason, it’s important to seek advice from an experienced pension adviser.  

It's important to note that annuity payments are designed to provide income throughout your retirement. Therefore, payments will cease upon your passing. 

Lump sums
The option to withdraw your pension fund in a lump sum gives you greater financial control in retirement.  You can take however much you want to out of your pension pot when you hit 55 and invest it, or simply spend it. This money can help you enjoy retirement and do all the things you wanted to without work commitments or other time constraints. 

However, your funds are finite, the more you withdraw the less the monthly payment and the harder you may find it financially later in life. You will also be liable for tax if you withdraw over 25%. 

Seek professional advice tailored to your circumstances and consider carefully before you decide! 

Contact our team of friendly, knowledgeable pension advisers to start planning your retirement.