Deciding how to create an income from your pension can be a hard decision to make, for many it is often a choice between a conventional Lifetime Annuity and Income Drawdown.
There is an alternative which is often over looked; the Fixed Term Annuity.
The Fixed Term Annuity is a relatively new creation and one which many people do not know exists. As proud members of the industry wide ‘Offer More Options’ campaign we are passionate about ensuring our clients make the best possible decisions at the time of their retirement.
The Fixed Term Annuity therefore needs to be considered as seriously as all the other options available.
What is a Fixed Term Annuity?
Fixed Term Annuities provide a level of income for a specific term with a Guaranteed Maturity Amount at the end of the term.
The income is guaranteed for the period of the fixed term and can include many of the usual options associated with a Lifetime Annuity, 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.
If a further Fixed Term Annuity is bought, the income can be reset according to requirements at that time and the limits imposed by the provider of the new Fixed Term Annuity.
This approach can enable people retiring to enjoy certainty with regard to their income payments, as they would with a Lifetime Annuity. However they have not committed to a Lifetime Annuity giving more flexibility in the future.
Fixed Term Annuities can also be useful for people 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.
The Fixed Term Annuity has a Guaranteed Maturity Amount and 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 April 6th 2011 of 55%. 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.|
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, obviously there can be no certainty which way Annuity rates will move 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
- You may prefer to have more flexible death benefits than those offered by a Lifetime Annuity
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 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 55% 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 three yearly GAD review. 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 FSA guides are available:
Additionally you can contact us for free to obtain advice with regard to your options in retirement by contacting us on 0845 074 7778 or 0115 933 8433 or by sending an email to email@example.com
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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.