'THIRD WAY' (also known as Fixed Term Annuities)
New pension products have become available over recent months. These are known as “Third Way” or “Fixed Term Annuities” and they provide guarantees such as:
- Income guarantee
- Fund value guarantee
These new type of products aim to provide an element of secured income, combined with some of the flexibility on an Income Drawdown plan. However, there are a number of different plans all offering different guarantees and different risks.
This type of plan is most appropriate for people who want the flexibility of an Income Drawdown but do not want their income to be directly affected by changes in the stockmarket.
Generally these products will guarantee to provide a set level of income based on a percentage of the fund value at outset for a guaranteed period of time. At the end of this period if the fund value has increased your income will be increased. If, however, your fund value has fallen your income will still remain at the existing guaranteed income level.
Some products will also “lock-in” the growth that has been achieved either on an annual basis or at an agreed date. Once the agreed growth is “locked in” this will be part of the guaranteed fund value at maturity or on death within the term.
‘Third Way’ annuities provide a guaranteed level of income for a specific term. An individual can choose the make up of the temporary annuity selecting the benefits that are most important to them, for example spouse’s pension, guaranteed periods, value protection, and indexation.
At the end of the term a Guaranteed Maturity Amount is provided with which a further ‘Third Way’ annuity can be purchased or a conventional Lifetime Annuity bought. Other options may also be allowable at this point dependent upon the pension legislation in force. NB. The Guaranteed Maturity Amount must stay within a pension arrangement of some kind and cannot be paid out to you.
If a further ‘Third Way’ annuity is bought the income can be reset according to requirements at that time.
However, the ‘Third Way’ annuity must end before the annuitant’s 77th birthday. At this time, the matured fund can be used to buy a conventional annuity, or be transferred to an Unsecured Pension arrangement.
This approach enables people retiring to enjoy certainty with regard to their income payments, as they would with a Lifetime Annuity, but only for the term selected, rather than throughout life.
The ‘Third Way’ annuity provides future flexibility by offering the ability to change the amount and shape of income at agreed intervals in retirement.
There is no minimum level of income that needs to be taken, which means you can take the tax-free cash alone and defer income to a later time.
This type of annuity can be free of investment risk and is therefore suitable for clients who want minimal risk. The income payments are guaranteed, as well as the Guaranteed Maturity Amount available at the end of the term, which is known at the outset of the arrangement.
As mentioned above there are various benefits that can be added to this style of annuity, these can be summarised as follows:
Some annuity contracts offer, upon your death, to pay back to your estate the value of your original investment less the total of any income paid to date. This ensures that overall you, or your estate will at least receive your money back over the contract period, subject to a potential tax charge of 35%.
It is possible to add a guarantee to this annuity, although this cannot be longer than the annuity period you have chosen. On the death of the annuitant the income will continue to the end of the guarantee period, which commences at the start of the annuity.
Value Protection and Guarantee Periods are mutually exclusive. You can have one or the other, but not both.
If you are married or have a financially dependent partner, the annuity can be set up to continue paying them an income after you have died. This can be at the full rate, or at a reduced level of two thirds or a half. However, this continuing income is payable for the remainder of the fixed term, with the Guaranteed Maturity Amount then being available for reinvestment by the surviving spouse / partner.
You can chose to have your income paid in a frequency that suits you.
You can chose to have income remaining level or rise to help offset the effects of inflation.
‘Third Way’ Annuities – Advantages & Disadvantages
- Immediate access to all of your tax-free cash.
- You can choose to take just the tax-free cash and no income.
- There is no exposure to investment risk.
- Your income is guaranteed for the fixed term of the annuity, provided it remains within allowable limits.
- The plan will also provide a Guaranteed Maturity Amount, known from the outset.
- At the end of the fixed term, you can use the Guaranteed Maturity Amount to purchase any allowable form of pension income product suitable for you at that time. As such it provides considerable flexibility.
- You may be eligible for an Enhanced Annuity if your health has worsened in the period between establishing the ‘Third Way’ annuity and the maturity date of the plan. This may lead to a significantly higher income.
- The Value Protection death benefit, if selected, ensures that your spouse or partner and/or dependants, or estate, receive the full value of the original purchase price of the annuity, less the value of any income payments actually paid. This benefit will be subject to a 35% tax charge unless reinvested in another appropriate pension product for the beneficiary.
- Income payments can be ‘guaranteed’ for a certain period so that they will continue to be paid for the remainder of the fixed period after your death. However, this cannot be used in conjunction with Value Protection.
- You can choose for a surviving spouse’s / dependant’s pension to carry on being paid after your death. The Guaranteed Maturity Amount is made available at the end of the fixed term to purchase any allowable form of pension income product, suitable for them at that time.
- The starting income for a Fixed Term Annuity is often less than for a comparable lifetime annuity, Essentially you are sacrificing a small amount of income in the short term to maintain flexibility in the longer term.
- Your pension options are fixed for the term of the annuity, and cannot be altered to take account of changes in personal circumstances during the term.
- The pension you receive is dependent upon annuity rates at the time of purchase – which are currently low when compared to historical rates.
- Whilst the Guaranteed Maturity Amount is guaranteed, the actual amount of income in the future will be dependent upon the prevailing annuity rates at the time. Your future income may be lower or higher than the current level of income.
- The maximum income you can take through a fixed term annuity is restricted by GAD rates. It is therefore possible that your income level may have to be restricted at the 5 yearly GAD review. There is a greater chance of this happening if you choose to take a high income above the default level.
- Unless you include inflation proofing, you are exposed to the risk of inflation eroding the value of your income during the contract term.