If you are approaching retirement and have pension savings from a private or company pension plan, then soon you will be faced with the decision of how to draw that money, and when.
Thanks to huge pension reforms introduced in April 2015, you have a number of options to consider when it comes to accessing your pension fund, all with their individual benefits and drawbacks.
One such option is a fixed term annuity – a product which has enjoyed a 68% increase in sales over the last year alone*.
How do fixed-term annuities work?
A fixed-term annuity enables you to enjoy a guaranteed income, but instead of it being paid throughout your life as with a lifetime annuity, it is paid for a term you select between one and twenty-five years – the amount of time is your decision.
At the end of your fixed term, you will receive a Guaranteed Maturity Amount to buy a further retirement income product or take out as cash, albeit subject to tax.
There are a number of reasons why retirees opt for this product over a lifetime annuity or a drawdown product, for example. Here, we consider why fixed-term annuities have become so popular in recent years.
Reduce tax payable on income
Since the introduction of the pension reforms, you can withdraw whatever level of lump sum or income you want from your pension fund. While this may sound great initially, the reality is that the tax implications can make the transaction significantly less attractive!
Only the first 25% of your pension fund can be withdrawn as a tax-free lump-sum, leaving the remainder – a huge 75% of your fund – subject to tax at your marginal rate, as it is added to your income in the tax year you take it. It could mean a tax charge of 40% or even 45% on your remaining pension fund.
To minimise the tax implications, some retirees select a fixed-term annuity to effectively ‘strip out’ their money over several tax years, thus reducing the impact of tax on their pension fund.
The main risk when using a fixed-term annuity for this purpose is if this will leave you without the means to purchase a guaranteed income in the future. You will then need to carefully consider how else you intend to fund your retirement.
If, however, a guaranteed income for life is not required from your fund, then a fixed-term annuity could help you to minimise the risk of moving into a higher tax bracket, for example, when withdrawing your fund as cash.
Retirement Line are not tax specialists. If you are unsure of the tax implications of purchasing a particular retirement income product, you should seek advice from an accountant or independent financial adviser.
Taking tax-free cash without the income
You may wish to access your tax-free cash now, but not start taking any income from it just yet.
Perhaps you have reached 55 and would like to make some major home improvements, or pay off your remaining mortgage to enjoy a bigger disposable income in your build up to retirement?
A fixed-term annuity will enable you to withdraw up to 25% of your pension fund as a tax-free cash amount to spend however you choose. Your Guaranteed Maturity Amount will then be paid to you at the end of the term, when you decide then whether to purchase another fixed term annuity, a lifetime annuity, take the remaining fund as cash, or purchase another retirement income product.
Delay making a decision
If you are disappointed with the current low lifetime annuity rates, for example, then a fixed-term annuity would enable you to delay purchasing your lifetime annuity whilst still enjoying your tax-free cash sum and taking an income from your fund.
You could potentially benefit from increased annuity rates at the end of your selected term, as interest rates may be higher. You will be older, too, which means you will be more likely to secure a better rate for life (rates increase as you get older).
You may also qualify for an enhanced annuity if your health deteriorates during the term of your fixed-term annuity. Developing something as common as high blood pressure in later life could mean thousands of pounds more income being offered to you.
Please note, annuity rates could also drop further in the future, so the income you secure in later years from whatever rates are available at that time may not be sufficient to provide the level of income you might hope for. The only way to avoid being affected by any future rate falls is to purchase a lifetime annuity.
Filling in the gaps
Fixed-term annuities can also be used to top up your income between your other retirement incomes kicking in.
For example, if you retire at 60 but your State Pension and Defined Benefit (aka Final Salary) pension do not start paying out until you are 65, then you will likely require an income during those five years to tide you over.
A fixed-term annuity for a term of five years could be arranged to provide the income you require to take retirement at the age you planned, rather than being forced to work for another five years.
Are they right for me?
We all have different wants and needs for retirement, but financial security is always going to be a key priority for most people. A fixed term annuity provides some of the features and flexibility of drawdown, but without the investment risk. However, if you want to take your retirement knowing your income is fixed for life, then a lifetime annuity is still the only way to achieve this.
Please remember that a fixed-term annuity guarantees that your income is paid to you only for the number of years you agree at the outset. As that can be up to 25 years, there is still a degree of certainty you can enjoy with them.
Uncertainty around how much income you will be able to purchase at the end of your guaranteed period is the main risk associated with a fixed-term annuity.
Fluctuations in market conditions could mean that annuity rates may be lower in the future should you be looking to purchase a lifetime annuity with the money from the guaranteed annuity amount.
But as mentioned before, it is possible that the retirement income you qualify for at the end of the fixed-term period could be higher than what you would be offered today. Improved rates, your older age, or qualifying for an enhanced annuity could all get you more money.
Speak to a specialist
There is much to consider when deciding how to take your retirement income. The world of pensions can seem daunting, but with the help of our friendly specialists we can help you to understand all of your options and give you all the information needed for you to make the right choice for your individual needs.
Call 0800 652 1316 to discuss your options and to receive your FREE retirement options report.
Retirement Line work on a non-advised basis. If you are at all unsure of which options suit you, you should seek regulated advice.
*Retirement Line H1 2016 customer data