Best way to top up your state pension – BIG decision facing everyone at retirement | Personal Finance | Finance

When we reach retirement age at 66, the vast majority of us automatically trigger our State Pension, but that’s the straightforward part. We also have to decide what to do with our various workplace and personal pension pots.

Ever since 2015’s pension freedom reforms, pensioners can choose between leaving their money invested via drawdown, or locking into a lifetime income via an annuity.

The vast majority have chosen drawdown, because returns on annuities collapsed after the financial crisis.

Yet the decision is now harder, because annuity rates have finally started to recover after more than a decade in the doldrums.

A 65-year-old buying a single life level annuity with a £100,000 pension can now get income around £5,600 a year, according to Hargreaves Lansdown.

That’s up from £4,882 last year, which means pensioners buying an annuity can get £718 more income than they did last year.

That follows the Bank of England’s move to increase interest rates four times since December, to today’s one percent.

Annuity providers say demand is picking up as a result, but most pensioners still prefer to leave their money invested via drawdown, rather than lock into an annuity.

Is this still the best move?

An annuity gives you a guaranteed income for life, no matter how long you live, but once you have bought one you are locked in for good. So you get security at the expense of flexibility.

With drawdown, retirees leave their money invested in shares to grow in value, while drawing money as required.

This offers maximum flexibility but with less security, because if the stock market crashes, the value of your drawdown pot will crash with it.

There is also the danger that you will use up your pension too quickly, leaving nothing for later life.

READ MORE: Claim your state pension right away – step everyone must take at 66

Annuity rates are improving, but they still have a long way to go, said Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown. “The income is still much lower than before the financial crisis.”

Another problem is that if you buy a level annuity, your income will stay flat for life, which means it will shrink in real terms due to inflation.

“You can buy inflation-linked annuities but the starting income is markedly lower, and it can take years to catch up,” Morrissey said.

A 65-year-old who used £100,000 to buy a single life escalating annuity, where the income grows 3 percent each year, would only get £3,916 in year one.

Another downside is that once you buy an annuity, you cannot change your mind, even if rates rise later. That is frustrating millions of pensioners today.

One of the big criticisms about annuities is that when you die, the income dies with you, but there are two ways around this, said Stephen Lowe, director of later life advice as Just Group. “First, couples can take out a joint life annuity, that will continue to pay 50 percent income to a surviving spouse or partner.”

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Alternatively, it is possible to buy an annuity with a policy feature called value protection, which allows you to pass on the remaining money to loved ones when you die. “This will cost more but could be worth buying if you are worried,” Lowe said.

It is not an all-or-nothing decision, said Andrew Tully, technical director of Canada Life. “You could use a small part of your pension to buy an annuity, to give you a guaranteed income to cover the essentials, and leave the rest invested in drawdown.”

You could then buy another annuity later, when you will get a higher income as your life expectancy will be lower. “Many older people lock into annuities because they do not want the responsibility of making drawdown investment decisions in later life,” Tully added.

The choice between an annuity or drawdown is complex and personal, so consider taking independent financial advice or talking to the free Pension Wise guidance service.