We are proud members of the industry wide ‘Offer More Options’ campaign and are passionate about ensuring our clients make the best possible decisions at the time of their retirement.
Many people know that an Annuity is one option for them, although in practice only about one third of people shop about for the best rate, and many also know that Income Drawdown is available. However, over the past couple of years, there has been more development in this area, the result being Third Way Annuities.
We thought we would shed some light on these new products and have asked our Director, Anna Timms, (left) to explain more.
What is a Fixed Term Annuity?
There are a number of Third Way Annuity products, the most popular being a Fixed Term Annuity.
Other types include Unit Linked and With Profit Annuities, however due to their increasing popularity and the fact that they are so new I will discuss only Fixed Term Annuities in this article.
When can it be used?
Fixed Term Annuities are used by people wishing to create an income from their pension fund and offer a half way house, or ‘third way’ for those people that, for whatever reason, do not wish to commit to a Lifetime Annuity but also do not wish to invest in an Income Drawdown contract.
In our experience there are many reasons why an individual may not wish to commit to a Lifetime Annuity:
- You may believe that Annuity rates will rise in the future
- You may not want to make a decision with a pension fund now that will be binding for a lifetime
- You may wish to try and delay the date at which you purchase an Annuity so you can benefit from a possible enhanced annuity in the future
Fixed Term Annuities provide a guaranteed level of income for a specific term. An individual can choose the make-up of the temporary annuity, selecting the benefits that are most important to them, for example, a spouse’s pension, guaranteed periods, value protection, and indexation. There is no investment risk.
At the end of the fixed term, you can use the Guaranteed Maturity Amount to purchase any allowable form of pension income product suitable for you at that time. As such it provides considerable flexibility.
If a further Fixed Term Annuity is bought, the income can be reset according to requirements at that time.
We find that this approach enables people retiring to enjoy certainty with regard to their income payments, as they would with a Lifetime Annuity, but only for the term selected, rather than throughout life, the main benefit being additional flexibility in future years.
We have also found that they are useful for clients who, for whatever reason want access to their tax free lump sum now, but do not require an income. Clearly such a decision would reduce their income in retirement, however it can be a useful facility in the right circumstances.
A Fixed Term Annuity can be free of investment risk and we find it is therefore suitable for clients who want minimal risk. The income payments are guaranteed, as well as the Guaranteed Maturity Amount available at the end of the term, which is known at the outset of the arrangement.
As mentioned before there are various benefits that can be added to a Fixed Term Annuity, these can be summarised as follows:
Value Protection Some annuity contracts offer, upon your death, to pay back to your estate the value of your original investment less the total of any income paid to date. This ensures that overall you, or your estate will at least receive your money back over the contract period, subject to a potential tax charge from 6th April 2011 of 55% (35% on death before 6th April 2011). There is no tax charge if the money is reinvested in another appropriate pension product for the beneficiary.
Guaranteed Period It is possible to add a guarantee to the Fixed Term Annuity, although this cannot be longer than the Annuity period you have chosen. On the death of the Annuitant the income will continue to the end of the guarantee period, which commences at the start of the Annuity.
Value Protection and Guarantee Periods are mutually exclusive. You can have one or the other, but not both.
Spouse’s Pension If you are married or have a financially dependent partner, the annuity can be set up to continue paying them an income after you have died. This can be at the full rate, or at a reduced level of two thirds or a half. This continuing income is payable for the remainder of the fixed term, with the Guaranteed Maturity Amount then being available for reinvestment by the surviving spouse / partner.
Frequency You can chose to have your income paid in a frequency that suits you.
Indexation You can chose to have income remaining level or rise to help offset the effects of inflation.
In our experience there are a number of advantages for a Fixed Term Annuity over a Lifetime Annuity, some of which are:
- Immediate access to some or all all of your tax-free cash
- You can choose to take just the tax-free cash and no income
- There is no exposure to investment risk.
- Your income is guaranteed for the fixed term of the annuity, provided it remains within allowable limits
- The plan will also provide a Guaranteed Maturity Amount, known from the outset
- At the end of the fixed term, you can use the Guaranteed Maturity Amount to purchase any allowable form of pension income product suitable for you at that time. As such it provides considerable flexibility
- You may be eligible for an Enhanced Annuity if your health has worsened in the period between establishing the Fixed Term Annuity and the maturity date of the plan. This may lead to a significantly higher income
- The Value Protection death benefit, if selected, ensures that your spouse or partner and/or dependants, or estate, receive the full value of the original purchase price of the annuity, less the value of any income payments actually paid. This benefit will be subject to a 35% tax charge unless reinvested in another appropriate pension product for the beneficiary
- Income payments can be ‘guaranteed’ for a certain period so that they will continue to be paid for the remainder of the fixed period after your death. However, this cannot be used in conjunction with Value Protection
- You can choose for a surviving spouse’s / dependant’s pension to carry on being paid after your death. The Guaranteed Maturity Amount is made available at the end of the fixed term to purchase any allowable form of pension income product, suitable for them at that time
Of course there are always disadvantages to a product, some of which are as follows:
- The starting income for a Fixed term Annuity is often less than for a comparable Lifetime Annuity, essentially you are sacrificing a small amount of income in the short term to maintain flexibility in the longer term
- Your pension options are fixed for the term of the annuity, and cannot be altered to take account of changes in personal circumstances during the term
- Whilst the Guaranteed Maturity Amount is guaranteed, the actual amount of income in the future will be dependent upon the prevailing annuity rates at the time. Your future income may be lower or higher than the current level of income
- The maximum income you can take through a fixed term annuity is restricted by GAD rates. It is therefore possible that your income level may have to be restricted at the GAD review, which will now take place every three years from 6th April 2011. There is a greater chance of this happening if you choose to take a high income above the default level
- Unless you include inflation proofing, you are exposed to the risk of inflation eroding the value of your income during the contract term
Making the decision between the range of retirement options available to you requires careful consideration and full knowledge of all the options available to you.
We have a number of additional resources for you to help you make a decision.
The following Money Made Clear guides are available (guides are available in PDF to download, save or print, if you would prefer a copy to be sent to you please email email@example.com putting the name of the guide you require in the subject heading):
Additionally you can contact one of our team of highly qualified advisers who can be reached on 0115 933 8433 or 0845 074 7778 alternatively you can send an email to firstname.lastname@example.org or complete the enquiry form on this page.
Learn more about how we give advice by clicking here.
Whatever route you pursue, take advice. The decisions you make will affect your income for the rest of your life and many cannot be changed.