A fixed term annuity is a type of annuity that provides a guaranteed income for a set period of time, typically 3 years to 20 years. They can be very useful for bridging a gap in income, for example for someone wanting to retire a few years before state pension age.
How do they work?
The minimum age at which you can buy a fixed term annuity is 55, increasing to age 57 from April 2028.
The fixed term annuity is purchased with the taxable proportion of your pension fund (after payment of the tax-free lump sum). There are various insurance companies that offer fixed term annuities, and you can shop around for the best annuity rate and the most suitable option.
The annuity provider pays you a guaranteed taxable income for the term that you select, with a guaranteed maturity value at the end. You can choose to have no income paid, which takes away the investment risk during the term, as the maturity value is still guaranteed. You can also choose to have the maximum income paid, with no maturity value and your pension fund fully used up.
You can choose to have the income paid monthly, quarterly or annually, either in advance or in arrears. A level annuity will pay the same amount (before tax) throughout the term, while an increasing annuity will start at a lower amount but then increase on an annual basis, to provide some protection against inflation.
You can also build in death benefits, so the remaining fund can be paid to a beneficiary in the event of your death.
At the end of the fixed term, any remaining fund can be moved into income drawdown, to provide flexible access, taken as a taxable lump sum or used to buy another annuity (fixed term or lifetime).
Advantages
A fixed term annuity provides certainty of income for a set period of time.
They offer much greater flexibility than a lifetime annuity, in that you can reassess your financial needs at the end of the term.
They can be combined with other sources of pension income, for example part of a pension could be used to purchase a fixed term annuity while the remainder stays invested to allow flexible withdrawals.
The annuity provider takes the investment risk and guarantees the maturity value.
Disadvantages
Purchasing a fixed term annuity with a guaranteed maturity value means having to make a further decision on what to do with the fund on maturity, potentially incurring further costs.
The returns may be lower than you would receive from keeping your pension fund invested.
The term of the annuity is fixed at outset, and you cannot normally change your mind after the initial cooling off period.
Unlike a lifetime annuity, any health issues are not normally taken into account when setting the annuity rate.
Annuity rates and market conditions could be less favourable in the future, when you receive your maturity value.
The income from a fixed term annuity paid on a level basis reduces in real terms over time, as inflation eats into the purchasing power of your money.
In summary
A fixed term annuity can be a really good option in some circumstances, but it is really important to think through what happens when the term comes to an end.
As with all retirement products, you should only set up a fixed term annuity if you fully understand the benefits to you, as well as the costs, risks and disadvantages.
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.
This article is for information only and should not be construed as advice or a recommendation. You should always seek independent financial advice prior to taking any action.
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