Pension pot decision: Should I consider halting drawdown and buying an annuity? (Stock image)
I retired in 2021 and moved one of my pension pots to a large firm via a financial adviser.
After taking my 25 per cent tax-free lump sum I was left with just under £50,000.
From this, I agreed to take £3,000 per year for five years, starting in March 2022.
I am now wondering if I would be better off if I discontinued the current drawdown (three years still to go) and took the remaining amount as an annuity given that interest rates are much higher now and therefore I assume annuities will have improved also.
Would I have to use the same firm for the annuity as they currently hold my pension pot or am I able to shop around and will the transfer incur any fees?
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Steve Webb replies: In a world where many people reach retirement with very small pension pots, the most common choice by far is to cash in the whole lot, taking a tax free lump sum and paying tax on the rest.
But, over time, more people will be in the same position as you, having built up a more meaningful pot.
In this case, cashing in the whole lot may not be the best option as you could face a big tax bill and you may miss out on the chance to grow your pot further.
The question then arises as to how your money should be invested post-retirement.
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Under rules set out by the Financial Conduct Authority, your pension provider has to ask you about your plans for the next five years, and will then make choices about how your money is invested based on your answer.
This process is known as putting you on an ‘Investment Pathway’.
Under the rules, you are given four options to choose from regarding your plans:
A. I have no plans to touch my money in the next five years;
B. I plan to use my money to set up a guaranteed income (annuity) in the next five years;
C. I plan to start taking my money as a long-term income in the next five years;
D. I plan to take out all my money in the next five years.
As you might imagine, the best way to invest your money might be rather different if you don’t need to touch your money at all for five years as against if you are going to take the whole lot out.
The idea of this process is to enable your pension provider to set things up in a way which best fits your intentions at retirement.
However, a very important point to be aware of is that you are not bound by the answer you give, and you can change your mind at any point.
You could also vary the amount you draw down, but always check the rules first in case there are limits or costs to having more flexibility.
In your case, it sounds as though at retirement you took your tax free lump sum but decided to leave the rest of your pot to be invested, drawing a relatively modest sum each year (option C from the list above).
But you are entirely free to do something different with your drawdown fund, whether because your circumstances have changed or because market conditions have changed.
In terms of using your fund to buy an annuity, the normal process would be for you to be given what is called an ‘Open Market Option’.
In simple terms this means you can take your money to any annuity provider and so you should shop around for the best rate you can get based on your own individual circumstances.
I would be surprised if your drawdown provider charged you for deciding to move out of drawdown but you should of course check with them before making any decisions.
On your wider point, you are quite right that annuity rates are now generally a lot higher than they were when you first took your pension a couple of years ago. But the rate of return you can get on money invested in your pension is also likely to be higher.
If you carry on investing you will be taking some investment risk but you will potentially benefit from a growth in the value of your fund.
On the other hand, if you buy an annuity you will enjoy the certainty of a guaranteed income but probably get a lower return overall.
The right answer will depend on your individual circumstances and how comfortable you are with the uncertainty of investing.
I have covered some of the pros and cons of buying an annuity in my previous column here: What is the best age to use my £220k pension to buy an annuity?
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