Investors looking to put off buying a traditional annuity on retirement, as income levels plunge to record lows, are being advised to take a cautious view of fixed-term plans that are sold as a way of keeping their pension options open.
Fixed-term annuities (FTAs) were launched in the UK five years ago, but have only recently started to gain a foothold in the market, as millions of savers have discovered that the income from lifetime annuities has fallen sharply.
According to the MGM Advantage Annuity Index, which records the income offered by annuities every quarter, the average rates from conventional and enhanced annuities fell by 4.15 per cent and 2.3 per cent respectively, in the three months to the end of September.
But advisers say investors will be gambling on future income levels if, instead, they opt for a short-term annuity, in the hope that rates may rise in the meantime.
With FTAs, investors exchange a lump sum from their pension funds for an income that typically lasts for 5 or 10 years. At the end of that term, a “guaranteed” sum is handed back to the investor, who can use it to buy another annuity.
Annuity providers claim that FTAs are therefore appealing to investors who want to retain control of their funds and “protect” the value of their retirement investment. Also, under FTAs, death benefits, net of inheritance tax, can pass to beneficiaries – this is not the case with conventional annuities, which effectively “die with you”.
However, while this offers investors a “third way” between an inflexible lifetime annuity and income drawdown direct from their pension funds, advisers warn that the risks should not be understated.
“On paper, these products look perfectly sensible for people who want to have an element of income security but don’t want to lock into a rate for life,” says Danny Cox, head of advice with Hargreaves Lansdown, the independent financial advisers. “But they are complex and they are second guessing annuity rates at the end of the term. There is a big risk of not replacing income if rates continue to fall.”
Advisers point out that the income offered by lifetime annuities is now higher than the income from FTAs.
At today’s rates, a 65-year-old man with a £100,000 fund could buy a traditional annuity paying £6,265 a year. In comparison a five-ear FTA would pay £5,900.
As a result, annuity rates would need to improve by more than 10 per cent by the end of the five-year period in order to match the lifetime annuity income – taking into account the fact that the now 70-year-old will have a smaller lump sum to invest.
“A lot of customers want to have their cake and eat it,” says Billy Burrows, director with the The Better Retirement Group. “They want guaranteed income and flexibility and choice, but the price customers pay for the flexibility is the risk future income could be less.”
Product providers say that anyone considering these plans should assess the risks with a financial adviser first.
FTA providers point out that their products also give investors the flexibility to improve their income if their circumstance or health changes. For example, if a retirees spouse dies, the next annuity purchase could be done on a single-life basis, giving a higher income than a joint-life annuity.
Similarly, if the retiree’s health worsens, the next annuity could be a higher-paying enhanced or impaired product. Some FTAs even allow this switch to be made before the end of the fixed term.
“A fixed-term annuity allows you to benefit should your state of health change,” says Stephen Lowe, spokesman for Just Retirement, a provider.”Whereas a conventional annuity pays the same rate for life, even when health declines.”
Clive Boulton, director of At Retirement, Aviva, adds: ”These plans are progressive and give people the opportunity to match their retirement income to changes in their lifestyle.”
Advisers note that while marketed as “annuities”, investors in these plans are subject to the same rules as retirees who choose capped drawdown from their pension funds. This means that they will be subject to three-yearly income reviews if they are under 75 or annual reviews if they are 75 or older – which could result in a fall in income
There are currently four providers of FTAs: Just Retirement, Aviva, LV= and MetLife.
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