What is a fixed term annuity and should I get one?

Buying a fixed-term annuity with some of your pension savings can offer you both the security of a regular retirement income and the flexibility to invest in a different product later.

If you like the idea of a regular income in retirement, but also the flexibility to change your mind later, a fixed-term annuity could be a good option.

Sometimes called short-term annuities, these products last from one to 40 years, although five to 10 years is typical.

Unlike a standard annuity, a fixed-term annuity means you’re not tied in for the rest of your life, so you can reassess your options when it ends.

What is a fixed-term annuity?

A fixed-term annuity is an insurance product that pays you a guaranteed income for a set amount of time, followed by a lump sum, known as a ‘maturity sum,’ paid when the annuity ends.

You are then free to look at other pension options with the cash, such as buying another annuity or opening a drawdown scheme.

How do fixed-term annuities work?

When you buy a fixed-term annuity, you pay a lump sum in return for a regular retirement income.

You can usually decide whether you receive income monthly, quarterly or annually.

The income you receive will depend on:

• The amount you pay for your annuity.

• Your provider’s annuity rates.

• The length of the annuity.

• Personal factors such as your age and state of health.

At the end of the fixed term you have chosen, you will usually receive a lump sum of cash known as the ‘maturity sum.’ 

This sum is made up of the money you paid originally, as well as investment growth minus the income you’ve already received. 

In most cases, this maturity sum is agreed at the outset, so you won’t be left with a surprise if the stock market performs unexpectedly.

In some cases, the maturity sum may be tied to investment performance. You can choose the amount of income you have paid to you, and this decision directly affects the maturity sum you receive.

If you choose to have a lower annuity income, you’ll receive a higher maturity sum and vice versa.

If you die before your fixed-term annuity ends, the remaining funds are usually paid to a named beneficiary, perhaps a spouse or family member.

The procedure for this can vary by provider and may also depend on the specific product you buy, so it’s advisable to seek financial advice.

You can also choose products where the payments continue after death for a period of time.

How are fixed-term annuities taxed?

Any annuity payments you receive will be taxed in the same way as normal income.

However, you can usually take up to 25% of your pension as a tax-free lump sum or a series of lump sums before buying an annuity.

Taking this money out tax-free rather than using it to buy an annuity is usually a more tax-efficient way to spend your retirement money, so you may wish to do this before or alongside buying a fixed-term product.

What are my options with a fixed term annuity?

Fixed-term annuities are noted for their flexibility.

You have control over many features, such as:

• The term (usually between five to 10 years).

• Single or joint (to also cover a spouse or civil partner).

• Whether your income always remains the same or whether a portion of it is linked to investment performance or set to rise over time.

• The purchase of add-ons, such as death benefits and inflation protection.

Some providers also offer additional options, such as enhanced annuities, for those with health conditions, which can impact the income you receive.

When considering a fixed-term annuity, always shop around. A financial adviser can help you do this.

Different providers will offer different fixed-term annuity rates, and the right choice can offer you thousands of pounds over the longer term.

Fixed-term annuity rates indicate how much you will receive each year for every £100,000 you invest.

For example, if you are offered a rate of 12% for 10 years and you pay £100,000, you will receive £12,000 a year,followed by the maturity sum at the end.

Once you’ve chosen your annuity, you can apply for it directly or go through your financial adviser.

How do I buy a fixed term annuity?

When considering a fixed-term annuity, always shop around. A financial adviser can help you do this.

Different providers will offer different fixed-term annuity rates, and the right choice can offer you thousands of pounds over the longer term.

Fixed-term annuity rates indicate how much you will receive each year for every £100,000 you invest.

For example, if you are offered a rate of 5% and you pay £70,000, you will receive £3,500 a year (followed by the maturity sum at the end).

Once you’ve chosen your annuity, you can apply for it directly or go through your financial adviser.

What are the pros and cons of fixed-term annuities?

To help you decide if a fixed-term annuity is the right option for you, it's important to weigh up the advantages and disadvantages.

What are the pros of fixed-term annuities?

• Flexibility: You can tailor the product to suit you, and you’re not tied in for the rest of your life.

• Security: You’ll receive retirement income each year and for a set amount of time. You could choose a guaranteed income product if you want to know exactly how much income you’ll get, but it might not be cost-effective.

• You will have the chance to earn more: At the end of the term, you could take out a new product at a better rate or benefit from an enhanced annuity if your health has deteriorated.

What are the cons of fixed-term annuities?

• You could receive less than you hoped for: If the product you opt for does not come with a guaranteed maturity value, you could receive less at the end of the term than expected if your investment underperforms.

• Inflation could rise: Unless you add inflation protection, you may find that the income you receive isn’t enough to live on if inflation increases.

• Exit fees: If you decide you want to move your money before the end of the term, it’s likely you’ll be penalised.

• It might not always be cost-effective: You might get more for your money with a different investment.

As with all investment products, fixed-term annuities come with risks.

Consulting with a financial adviser can help determine the best approach for your retirement income.

Get expert financial advice

A fixed-term annuity can offer a blend of security and flexibility, making it a viable option if you are looking for a steady income in retirement while retaining the ability to reassess your financial plans later.

However, it's essential to understand the potential risks and limitations, such as fluctuating annuity rates and inflation.

By carefully considering your options and seeking professional advice, you can determine whether a fixed-term annuity is the right fit for your retirement strategy.

Unbiased can quickly match you with a financial adviser for expert financial advice to help you navigate the complexities of fixed-term annuities and ensure they align with your long-term financial goals.