Annuity vs Drawdown: Choosing in 2026

At retirement, a defined-contribution pension pot does not pay an income by itself. The money has to be turned into income, and the two main routes are buying an annuity or moving the pot into income drawdown. The difference between an annuity and pension drawdown comes down to a single trade-off: a guaranteed income that someone else manages, or a flexible income that stays invested and that you manage.

Both routes let you take up to 25% of the pot as a tax-free lump sum first. What happens to the remaining 75% is where they part company. This guide sets out how each one delivers income, the risks attached to each, and the annuity-rate backdrop heading into 2026.

• Annuity: swaps the pot for a guaranteed income, usually for life, paid by an insurer.
• Drawdown: keeps the pot invested and lets you draw income flexibly, with no guarantee.
• Tax-free cash: up to 25% of the pot is tax-free under both routes, capped at £268,275 across all pensions.
• Taxable income: everything beyond the tax-free element is taxed as income in the year it is taken.
• Risk split: an annuity removes investment and longevity risk; drawdown leaves both with you.
• Annuity rates rose over the past couple of years as gilt yields and interest rates climbed.

How an annuity works

An annuity is a contract with an insurer. You hand over some or all of the pot, and in return the insurer pays a set income, normally for the rest of your life. Once it is set up there is nothing to manage and nothing to invest. The income arrives whatever happens to markets and however long you live, which removes both investment risk and the risk of outliving your money.

The income is fixed by the terms chosen at the outset. A level annuity pays the same amount each year and does not rise with inflation, so its buying power falls over time. An escalating annuity starts lower but increases each year. Adding a spouse's pension or a guarantee period also lowers the starting rate. Health and lifestyle factors can raise the rate through an enhanced annuity. The decision is generally permanent, so the terms cannot usually be changed once income has begun.

How income drawdown works

Flexi-access drawdown moves the pot into an arrangement where it stays invested while you draw income from it. There is no cap on how much you take and no minimum. You decide the amount and the timing, and you can vary or pause withdrawals. This suits people who want control, who expect to leave money to family, or who already have guaranteed income from a defined-benefit scheme or the State Pension covering essential bills.

The flexibility carries capital risk. Because the fund remains invested, its value can fall as well as rise. Drawing income while markets are down, or simply living longer than planned, can exhaust the pot. Taking any taxable income from drawdown also triggers the Money Purchase Annual Allowance, which sharply reduces how much can still be paid into pensions afterwards. Taking only the 25% tax-free cash does not trigger it.

The tax-free element and how income is taxed

Under both routes, up to 25% of the pot can be taken free of income tax, known as the pension commencement lump sum. This is capped at £268,275 across all pensions under the Lump Sum Allowance. The remaining 75% is taxable as income in the year it is received, stacked on top of the State Pension and any other taxable income. With an annuity the taxable income arrives as a fixed regular payment. With drawdown the taxable income is whatever you choose to withdraw, so the tax position can be managed year by year.

Comparing the trade-offs

The choice is rarely all or nothing. Some retirees use an annuity to cover essential spending and keep the rest in drawdown for flexibility. The table sets out the main contrasts.

The annuity-rate backdrop in 2026

Annuity rates are driven largely by UK gilt yields, because insurers back the guaranteed income with government bonds. As interest rates and gilt yields rose over the past couple of years, annuity rates improved markedly. By mid a single-life level annuity for a 65-year-old was paying broadly in the region of 7.8% to 7.9% a year from the leading providers, a level far above the lows seen during the era of ultra-low interest rates. Rates move with the gilt market, so the figure available on any given day will differ. Drawdown income, by contrast, is not set by a rate at all; it depends on how the invested fund performs and how much is withdrawn.

The route that fits depends on attitude to risk, other sources of guaranteed income, health, and plans for passing funds on, all of which differ from person to person.

This article is for general information only and does not constitute financial, tax or regulatory advice. Kaeltripton.com is not authorised or regulated by the FCA. Pension and tax rules differ by country of residence and change over time. Verify any figure with official sources such as GOV.UK, HMRC or the FCA, and take advice from a suitably authorised adviser in your country of residence before acting.

FAQ

What is the main difference between an annuity and pension drawdown?

An annuity swaps your pot for a guaranteed income paid by an insurer, removing investment and longevity risk. Drawdown keeps the pot invested and lets you draw income flexibly, leaving those risks with you.

Can I take 25% tax-free under both options?

Yes. Up to 25% of the pot can be taken as a tax-free pension commencement lump sum under both routes, capped at £268,275 across all pensions under the Lump Sum Allowance. The rest is taxed as income when taken.

Can my drawdown pot run out?

Yes. Because the fund stays invested, its value can fall, and drawing income while markets are down or living longer than expected can exhaust the pot. An annuity income, by contrast, continues for life.

Why have annuity rates risen recently?

Annuity rates are driven mainly by UK gilt yields. As interest rates and gilt yields rose over the past couple of years, insurers could offer more income, pushing rates well above their earlier lows.

Can I use both an annuity and drawdown?

Yes. Many retirees use an annuity to cover essential spending and keep the rest in drawdown for flexibility, combining a guaranteed base income with access to invested funds.