Cash vs Annuity

These are usually workplace pensions arranged by your employer. They’re sometimes called ‘final salary’ or ‘career average’ pension schemes. The pension provider will promise to give you a specific amount each year when you retire which maybe inflation linked. You may also be offered a 25% tax free lump sum and a reduced annuity payment.

Some schemes move your money into lower-risk investments as you get close to retirement age. You may be able to ask for this if it does not happen automatically - ask your pension provider

These are usually either personal or stakeholder pensions and sometimes called ‘money purchase’ pension schemes. They can be workplace pensions arranged by your employer, or private pensions arranged by you. Money paid into the scheme by you or your employer is put into investments (such as shares) by the pension provider. The value of your pension pot can go up or down depending on how the investments perform.

Some schemes move your money into lower-risk investments as you get close to retirement age. You may be able to ask for this if it does not happen automatically - ask your pension provider

A (Cash Equivalent Transfer Value) CETV is required where a pension member wishes to switch from a final salary scheme (also known as a ‘defined benefit’ plan) into a defined contribution scheme. It shows the total cash value of your Defined Benefit plan. Your pension scheme administrator will be able to provide you with a CETV statement. You will need a CETV in order to consider whether it is suitable to transfer a Final Salary Pension into an alternative vehicle such as a Personal Pension or a Self-Invested Personal Pension (SIPP).

Consumer Price Index (CPI) and Retail Price Index (RPI) are measures of inflation. RPI includes the costs of housing (mortgage interest costs and council tax for example) while CPI does not. If your Defined Benefit pension is linked to inflation the scheme will define whether it uses RPI or CPI to determine the annual increase.

An Annuity is paid every year (normally monthly) and is subject to income tax - the longer that someone lives the more beneficial an Annuity pension will be. Depending on the terms & conditions of the pension the Annuity may increase each year with inflation (CPI or RPI) or not. CPI and RPI are set using the OBR Forecast, currently 2% for CPI and 3% for RPI. Your pension scheme will define which of these inflation figures is used

For comparison we have set the cash returns rate at 1% but you can change this value in the Settings dropdown if you wish. The cash growth rate should be set to a rate you can earn with little-to-no risk (called the risk-free rate), an economist might use short-term Gilt yields (this is the interest you would earn from lending money to the UK government for a short period of time, and hence is almost zero risk of them not paying you back and minimal impact if interest rates change). It is important to use an cash returns rate with little to no risk for comparison as Annuity payments are guaranteed - this is no risk of you not recieving them.

In calculating income tax, we have assumed the person will be receiving a full State pension which will normally offset the Personal Tax Allowance and so the first £37,500 pension income will be taxed at 20%, and anything above £37,500 will be taxed at 40%. For post-tax calculations we reduce the cash line in proportion to the tax that is applied to the Annuity but as 25% of the Cash pension is tax free we only apply 75% of the value (e.g. If tax on Annuity is 20% then cash reduction is 75% of 20% = 15%).

The cross-over point on the chart shows the age that both Cash Drawdown and Annuity pensions are equal in value.

We assume that any beneficiaries living longer than the pension holder receive 50% of the annuity payment.