How do fixed-term annuities work?
Can you write an article explaining how fixed-term annuities work please? I’m 60 so feel like I don’t want to lock into an annuity quite yet, but I’m nervous about staying invested via drawdown.
I know you can’t give advice but can you explain the pros and cons?
Tom Selby AJ Bell Senior Analyst says:
Fixed-term annuities are a so-called ‘third-way’ retirement income product. They sit between traditional annuities, which require you to make a no-going-back commitment to convert your retirement pot into a guaranteed income for life, and drawdown, where your money remains invested and you take an income to suit your needs.
If you buy a fixed-term annuity, you will be able to choose how many years you would like to receive an income for and what lump sum you would like at the end of your term. Providers say investors usually choose terms of between five and 10 years.
To give you an idea of what you might get from a fixed-term product, I ran an example of a 60-year-old with a £100,000 fund buying a 10-year fixed-term annuity through the Money Advice Service annuity calculator. I assumed the person wanted a £50,000 lump sum on maturity.
The best quote available on 9 June 2020 was a £5,596 annual income over the 10-year term. While this compares favourably to a standard level annuity, which would buy a guaranteed income for life worth £4,204, it’s worth noting the returns you are getting are still pretty low.
Essentially, you’d have invested £100,000 at the outset and received £105,960 in total at the end of your 10-year term (£50,000 on maturity plus £55,960 in income).
That equates to a return of about 0.6% a year – roughly half the 1.16% annual interest rate you can currently get from the best easy-access cash account on the market, according to MoneySavingExpert. So if maximising your investment returns is a priority, it might be worth considering alternative routes.
If someone invested the same £100,000 in drawdown and enjoyed investment returns of 4% a year, for example, they could take an income of £7,700 over the same 10-year period and have a lump sum worth almost £52,000 at the end. However, investment returns are not guaranteed and your fund value could go down as well as up.
The main advantage of fixed-term annuities cited by providers is that the product offers the certainty of an annuity without committing your entire fund for life. This means if annuity rates improve or your health circumstances change, you might be able to get a better deal on a lifetime annuity at the end of your fixed term.
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