Using a fixed-term annuity to bridge an income gap

06 November 2024

Written by George Gilbert, Senior Annuity Specialist

Do you want to retire early but worry that you won’t have enough income or savings to live on? One solution might be to set up a fixed-term annuity to provide guaranteed income before other pensions start to pay out.

For some people, an income gap happens when they switch to a part-time job for a phased retirement. Others might want to retire fully a few years earlier than planned. 

Adjusting to a lower income in this period can be difficult, especially if you still have large bills like a mortgage to pay. That’s why it may be worth looking at whether a fixed-term annuity is the answer. It could be a way to bring you income and enormous peace of mind during this stage of your life.

On this page:

• What are fixed-term annuities?

• How fixed-term annuities can help

• How to choose the right fixed-term annuity for you

• Industry sees boom in fixed-term annuity sales

• Pros and cons of fixed-term annuities

• Speak to an annuity specialist for more information

What are fixed-term annuities?

An annuity is a financial product for people aged 55+ (57+ from 2028) that lets you turn your pension pot into guaranteed income. One option is a fixed-term annuity, which pays an income for a specific number of years of your choosing. People typically opt for a term of between five and ten years, but anything between one and 25 years is possible. 

Unlike a lifetime annuity, which pays out for the rest of your life, a fixed-term annuity finishes at the end of the set term. This makes it a potentially useful option if you need income to bridge a gap before the State Pension or another source of retirement income begins to pay out.

You can choose to receive the maximum income available from your fixed-term annuity, or take less income but in return know that there will be a lump sum available at the end of the term. Known as a Guaranteed Maturity Amount (GMA), this can be taken as taxable cash, or used to set up another income solution such as another annuity or an income drawdown plan.

You can read all about fixed-term annuities here, on our dedicated information page.

How fixed-term annuities can help

Research by Legal & General has revealed that 2.8million people in the UK aged 50+ have returned to work after retiring. Over a third of them (37%) stated they needed a greater income to cope with their living costs.

It’s clear that many people want to retire early, but lack the income to do so. Fixed-term annuities are potentially useful for those who wish to take an early or phased retirement, whether by choice or due to health issues. They provide a steady income until you can access other retirement funds, such as your State Pension.

To understand how a fixed-term annuity might help you, let’s consider an illustrative example:

Fixed-term annuity example - Carol, aged 60.

Carol is 60-year-old who isn’t yet eligible for the State Pension, which for her will start at age 67. She wants to ease into retirement by reducing her work hours to part-time, with the intention of retiring fully at 67. 

Carol knows that the income from her part-time job won’t be enough to cover all her expenses. However, she has a couple of pension pots available and decides to use one of them to buy a fixed-term annuity for seven years.

Her fixed-term annuity will provide a steady and guaranteed income stream, supplementing her part-time earnings and bridging the gap until she starts receiving the State Pension. She will keep her other pension pot invested, with the intention of using it to set up a lifetime annuity or income drawdown when she fully retires. 

This approach allows Carol to benefit from the stability of guaranteed income until retiring fully, while also enabling the potential for investment growth in her remaining pension fund.

(This is of course an illustrative example - please consider your own circumstances and get suitable information, guidance or advice to help you decide what is right for you.)

How to choose the right fixed-term annuity for you

You can shape your fixed-term annuity to match your circumstances and needs. It’s all about choosing the right blend of term length, income and Guaranteed Maturity Amount (GMA). 

For example, do you want to get as much regular income as possible from your fixed-term annuity? Or do you want to take less income, but set up a sizable GMA to pay out when you reach the end of your term? 

Here at Retirement Line, we can produce as many illustrations with different combinations of income and GMA as you need to let you fully compare your options. 

We can also explain how products from different annuity providers compare. Some providers may offer more flexibility than others, for example. We can also help you compare the very latest annuity rates from different providers to maximise your income from a fixed-term annuity.

Industry sees boom in fixed-term annuity sales

Awareness about fixed-term annuities would appear to be in the increase. L&G Home Finance CEO and Retail Retirement managing director, Lorna Shah, recently commented:

“We saw sales of fixed-term annuities more than double last year as customers sought the benefit of a predictable and flexible retirement income.

“Fixed-term annuities are often used in this way as a bridging option for those looking to boost their finances, while still receiving some form of income from work.”

The interest in fixed-term annuities was also reflected when Standard Life launched a fixed-term product in September 2024. With many people working in part-time or seasonal roles in later life, clearly there is a place for financial solutions such as fixed-term annuities, which can supplement existing income.

Pros and cons of fixed-term annuities

Fixed-term annuities offer several advantages that can make them an appealing choice for those nearing retirement:

• Predictable income. With a fixed-term annuity, you know exactly how much income you’ll receive and for how long. This predictability makes it easier to budget and plan for future expenses.

• Customisable features. Fixed-term annuities allow you to choose the term length that best suits your needs. You can also get the right balance of income and Guaranteed Maturity Amount to meet your financial requirements, whether you need a modest supplement or a more substantial income stream.

• Financial security. If you’ve taken early retirement, perhaps due to poor health, the security of a fixed-term annuity can be invaluable. It ensures you have a guaranteed income without relying on part-time work or investment returns, which can be unpredictable.

• No ongoing costs. Once your annuity is set up, you won’t have to pay any separate  fees or charges for the life of the plan.

However, while fixed-term annuities offer many benefits, there are a few important factors to keep in mind:

• Commitment to the term. Fixed-term annuities are designed to last for the full term. If you no longer need the income or want to access your funds early, you may be stuck. Some providers, however, do allow you to make a set number of additional withdrawals from your fund, though this naturally reduces the GMA you receive at the end.

• Tax implications. As with lifetime annuities and drawdown, the income from a fixed-term annuity is subject to income tax. This means that any income above your personal allowance will be taxable at your marginal rate.

• Using your pension pot. When you use a portion of your pension pot to buy a fixed-term annuity, those funds are typically no longer available for other uses. It’s important to balance your immediate need for income with your long-term financial needs.

Remember, fixed-term annuities should be viewed as one part of your overall retirement strategy. You might find that combining a fixed-term annuity with other income sources, such as part-time work, investments, or other pension products, can provide a diversified financial plan that complements your long-term goals.

Speak to an annuity specialist for more information

Here at Retirement Line, our team of Annuity Specialists is here to help you understand how a fixed-term annuity might fit into your overall retirement strategy. We can help you to understand your options and explore how much guaranteed income you could achieve from your pension fund. 

It’s important to shop around different annuity providers to make sure you’re getting the best annuity rate and income. This is also a core part of the service we provide to our customers.

To talk to an Annuity Specialist today, call us on 0800 652 1316 or email us at info@retirementline.co.uk.