Annuities and drawdown are the two main ways of using your pension pot to fund your retirement. But how are they different? What option is best for you? And what risks do you need to be aware of?

Our Money blog team has put together a guide explaining everything you need to know about the two options.

First, let's take a look...

DRAWDOWN

This is a way of managing how you spend your pension pot - and is a much more flexible way of accessing your pension than its main alternative, the annuity.

It allows you to take sums out gradually while leaving the rest invested.

Pension providers and investment platforms offer the product, which is generally available to people aged 55 and over (rising to 57 from 2028) with a defined contribution pension, and not final salary or defined benefit pensions.

How does it work?

You usually start by taking up to 25% of your pension pot tax-free.

The rest is moved into what's called a "drawdown account", where it remains invested in funds of your choosing, such as stocks or bonds.

You can take income from that invested pot whenever you like - but anything you withdraw beyond the tax-free portion (25%) is taxed at your income tax rate.

The risk

You have full control over how much to withdraw and how often, making it flexible for changing income needs - which sounds ideal.

However, because your pot remains invested, it can rise or fall depending on market performance.

Poor investment returns or withdrawing too much too soon could mean your money runs out in retirement. It can take just one volatile world event, such as Donald Trump imposing tariffs, to wipe significant value from your fund.

You also need to make sure you take responsibility for the drawdown - keeping an eye on how it's performing, when to take out lump sums etc.

If you don't plan properly and run out of money, that's on you.

ANNUITIES

This financial contract converts your savings into an annual income, like a state pension, rather than flexible drawdowns.

The product is sold by insurance companies to those aged 55 and over and can be fixed-term or lifetime.

Payments are made either annually, biannually, quarterly or monthly, and how much you receive depends on the size of your pension savings, the features of your particular annuity, and your health and lifestyle.

How does it work?

The annuity payment is an annual percentage of the amount you convert. So if you spend £100,000 of your pension savings on an annuity product at a 5% rate, you'll get £5,000 a year.

Once you've agreed to the contract, you cannot change your annuity, take out lump sums, or transfer it to someone else.

There are different types of annuity...

Fixed v lifetime

Lifetime annuities guarantee you a set income for the rest of your life, no matter how long that is.

Fixed-term or temporary annuities pay an income for a set period of time, often between three and 25 years.

This allows you to shop around for other options once the contract ends. Some people might use them as a bridge between retirement and the beginning of their state pension at age 66.

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What rates are available

There are various packages, so let's start with the simplest. Level annuities pay out the same amount of money each year but they are vulnerable to inflation, which can reduce your standard of living over time.

Escalating annuities provide a partial solution to this problem, increasing at a fixed percentage each year (eg 3%). The catch is that payments begin at a lower rate than level annuities.

Inflation-linked annuities rise in line with the retail price index (RPI), proofing your income against inflation, but starting at a much lower rate.

Investment-linked annuities invest part of your pension fund and pay out extra income - or not - based on the performance of the investment.

Impaired or enhanced annuities can be used if you have health issues that are expected to shorten your lifespan. This allows larger annual payments to be made on the basis that insurance companies expect to spread them over a shorter period of time.

Joint life annuities allow you to pay your spouse or partner after your death, but often at a lower rate. Or you can protect a lump sum in your initial agreement to be transferred to your loved one when you pass away.

Taxation

Annuities contribute to your personal allowance and, once that is reached, are taxable like any other income stream. Remember, you are entitled to draw down a 25% lump sum tax-free from your pension pot.

An annuity paid to a spouse or partner after your death is also subject to income tax, unless you die before the age of 75.

Advantages and disadvantages

In summary, here are the positives and negatives to consider.

Differences between drawdown and annuity

Here are the main differences between the two:

• Drawdown: Flexible access, investment growth potential, but no guaranteed income
• Annuity: Fixed, guaranteed income for life or a set period, but no flexibility or growth potential once purchased

Can you mix the two?

Yes - in fact, the number of people doing this is growing.

You can split your pension pot - buying an annuity with one part and using drawdown with the other.

This hybrid approach helps balance steady and secure income with the prospect of growth with the other - as well as control over your remaining funds.

(c) Sky News 2025: Everything you need to know about pension drawdown and annuities