Those approaching retirement may be toying with the choice of either purchasing a lifetime annuity or instead opting for income drawdown. These tend to be two of the most popular choices when it comes to deciding on what to do with your pension pot. However, you could well find that both these options could cost you in the long run. It must be said that taking a lifetime annuity does provide stability and a guaranteed income for the rest of your retirement. Which is why around half a million annuities are bought every year in the UK.
However they can be restrictive, for example if you purchase a standard life annuity and then suddenly incur a health condition that may shorten your life, you are locked in to the rate you agreed to when you bought the annuity. Another issue is that rates have fallen steadily, by around 30% for the average male with a lifetime annuity in the past 10 years some estimate. Given this fact, it is hardly surprising that they have become less appealing in recent times.
The second option on the table and one which many people (particularly those with larger pension pots) often opt for is called income drawdown. Under this scheme, your pension pot remains invested and you draw and income from the pot, based on the performance of the investments, although there is a minimum level of income that is guaranteed. However this can only be continued until you reach the age of 75 when either you must buy an annuity OR choose what is known as an alternatively secured pension. This, abbreviated to ASP, is similar to income drawdown but has extra rules over how much of an income you can draw. The amount you take from income drawdown will depend on many factors, for example if you were in your early fifties, you might not want to take an income at all and keep the money invested. The great benefit of income drawdown is that you can have control over when you buy an annuity, often waiting for favourable market performance and/or better annuity rates.
But as we all know, what can go up can also go down. And with the volatility of the stock market being as it is, those with money tied up in investments will have plenty to worry about on a day to day basis. So with annuities being somewhat restrictive and income drawdown liable to cause uncertainty, what other choices are out there for retirees? Well there is the option to take what are known as fixed term annuities. Although fixed term annuities have been on the market for a substantial number of years, some argue they have been largely ignored by pension providers as well as annuitants. In fact only two UK pension providers actually offer this product at the moment, that’s Living Time and LV= (Liverpool Victoria) – who incidentally only launched their product in the past few weeks.
As you might expect from the name, fixed term annuities, cover you for a set period of time. This can be anything from 3 years up to however long it takes you to reach 75. You choose the level of income you want to receive over this period. The provider also tells you the amount of money you will get back at the end of the period to buy another annuity. Both are guaranteed. However, initial income may be lower than what you might expect under a conventional lifetime annuity. But it should be noted that this option is much more flexible. For example if you opt for a conventional annuity at age 60, you may only qualify for a standard rate as there was no medical condition that would have impacted on your life expectancy. However by the time we all reach the ripe old age of 75, around half of us will have something that will be medically wrong with us. Now with a lifetime annuity bought at age sixty, you are stuck with the standard rate. However if you acquire a fixed term annuity at age 60, this could be set to expire at age 75 when you can opt for perhaps enhanced or impaired life annuities.
Although it might sound a bit strange to plan your finances around the notion of becoming ill in the future, did you know that some enhanced schemes pay up to 75%% more than standard life annuities. If something does effect you medically in the future you’ll be glad you chose a fixed term annuity. The major advantage fixed term annuities have over income drawdown is that they eliminate the concern over the performance of the stock market, which battered many a pension pot in the last two years. Moreover you get the secure feeling that an annuity provides without the restrictiveness. Many in the pension industry will be hoping that other major pension providers in the UK will start to offer this product given it’s benefits and flexibility.
