Updated 13 March 2018
For those at retirement who are reluctant to lock themselves into a lifetime annuity there are alternatives to unlock your annuity, explains Jeff Miller.
For those people at retirement who are reluctant to lock themselves into a lifetime annuity, but need an income now, the alternative is to opt for one of the arrangements covered by a pension drawdown. There are a number of these, and they come with varying levels of risk.
What is an pension drawdown?
A pension drawdown is a way of taking an income from the money you’ve built up in your pension fund. People are usually eligible for this from the age of 55. You can either use this money to retire fully or just some to supplement your income. It allows you to release a lump sum of up to 25 per cent of your fund tax-free, as well as make income withdrawals up to a maximum allowance which, unlike the lump sum, will be taxable as income.
Unlike a lifetime annuity, which (unsurprisingly) lasts a lifetime, a fixed-term annuity lasts for a fixed period of time. At the end of this fixed period, the fixed-term annuity returns a guaranteed maturity payment, which can then be used to purchase a lifetime annuity or another retirement income plan (another fixed-term annuity perhaps).
So far so good.
Most fixed-term annuities also provide an option to convert the plan into a lifetime annuity or another retirement income plan, providing that the retiree has taken financial advice.
A fixed-term annuity has a default annuity rate and guaranteed maturity payment set by the provider, and the combination of these is designed to pay a competitive income for a period of time, and a sum at maturity that will purchase a similar level of income based upon current annuity rates. Annuity rates do change, and may vary considerably over a period of several years.
The guaranteed maturity payment that is set using the default rate will always be lower than the purchase price of the fixed-term annuity. This is because the retiree will, as the older plan matures, need a smaller fund to produce the same level of income than they did at the inception of the fixed-term annuity.
The retiree does not have to accept the default annuity rate and guaranteed maturity payment set by the provider. He or she can choose an income between nil and the maximum GAD rates (government actuary’s department rates), which is the same option that is open to all arrangements covered by the drawdown regime. The key issue here is that the guaranteed maturity payment is determined by the level of income selected at the outset. Again, that makes sense: there is an amount of money to go round, and you either get it returned to you as ongoing income or returned as maturity capital.
It is worth reiterating that a fixed-term annuity cannot pay a higher income than the maximum GAD rate, and as the GAD rate is reviewed triennially, the income produced from a fixed-term annuity can potentially fall during the fixed term.
It is important to note that you should always seek professional advice before entering into any retirement income plan.