Drawdown Versus Annuity for a Client With a Health Impairment
Tom, 66, is retiring with a €310,000 defined contribution pension pot. He is single, has no dependants, and his state pension covers basic costs. He has moderate COPD and his GP has confirmed a reduced life expectancy. Tom wants the highest sustainable income and is uncomfortable with investment risk, but his adviser notes he could live 15+ years. He is deciding between an immediate lifetime annuity (level, no escalation) and income drawdown invested in a cautious multi-asset fund with ongoing charges of about 1.4% a year. He has €40,000 in cash savings and owns his home outright. He asks whether drawdown 'keeps his options open' is worth the extra risk and cost in his circumstances.
1. Compare the two options for Tom, focusing on how his health and risk tolerance change the usual trade-offs.
Read the worked answer
The usual drawdown-versus-annuity trade-off (flexibility and death benefits versus guaranteed income and no investment risk) is tilted here by two facts: reduced life expectancy and no dependants.
- Annuity: A level lifetime annuity locks in a guaranteed income for life. Because Tom has a confirmed health impairment, he should be underwritten for an enhanced/impaired-life annuity, which pays a higher rate than a standard annuity for the same pot. With no dependants, the death-benefit advantage of drawdown is largely irrelevant to him - a single-life annuity with no guarantee or a short guarantee period maximises income.
- Drawdown: Keeps the fund invested, so it carries sequence-of-returns and market risk, plus ~1.4% annual charges that compound against him. Its main advantages - flexibility, control, and passing on an unused fund - matter less given his priorities and lack of dependants.
Given his stated discomfort with investment risk and his desire for maximum sustainable income, an enhanced annuity is likely the better fit, provided he understands it is irreversible.
2. Identify the risks Tom should weigh if he nevertheless chooses drawdown, and how they could be mitigated.
Read the worked answer
Key drawdown risks for Tom:
- Longevity/decumulation risk - if he lives longer than expected, the fund could be depleted. Mitigate with a sustainable withdrawal rate (reviewed annually) rather than a fixed high percentage.
- Investment/sequence risk - poor early returns while withdrawing permanently damage the fund. Mitigate with a cautious portfolio and possibly a cash buffer of 1–2 years' income so he is not forced to sell investments in a downturn.
- Charge drag - 1.4% a year plus fund costs erodes the pot; he should compare cheaper platforms/funds.
- Irreversibility of decisions - a partial annuity (annuitising part of the pot for guaranteed core income) plus drawdown for the remainder is a legitimate hybrid that hedges both ways.
He should also confirm how any means-tested benefits and tax on withdrawals interact with his income before committing.