One of the main attractions of drawdown is that when the policholder dies any remaining fund can be
paid to the family less 35% tax (probably 55% after 2011), whereas with an annuity the capital is lost on death.
The comparison between drawdown and annuities is more complex than it seems
because there is an invisible force at work called mortality drag.
When you buy an annuity you benefit from a mortality cross subsidy but this is not present in drawdown and the effect is known as mortality drag.
Annuities are based on the principle of mortality cross subsidy where those who die before their normal life expectancy subsidise those who live longer than expected.
Drawdown results in the deferral of annuity purchase and so the investor does not benefit from the mortality cross subsidy.
This means that in order for a drawdown fund to provide the same income as an annuity there has to be an extra investment return each year to compensate for the absence of this subsidy.
The chart below shows the investment growth required year on year in order that the drawdown could purchase the same
level of annuity income.
The chart shows that the older you are the greater the impact of mortality drag and means that
the risk of drawdown increases with age. This is often used to justify the concept
of "phased annuities" where segments of drawdown are converting into annuities
at regular intervals in oder to reduce the effects of mortality drag.
This website is run by William Burrows, is for information only and does not provide specific financial advice.