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Fixed-term annuity savers hit by low investment returns

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Savers who bought a fixed-term annuity five years ago could be left up to 18 per cent worse off than someone who bought a lifetime annuity.

Enhanced annuity specialist MGM Advantage has analysed the total retirement income a 65-year-old man with a pension pot worth £100,000 would receive if they had bought a five-year fixed-term annuity on 1 January 2008.

The provider’s analysis assumes that at the end of the term the individual buys an annuity based on their health at the time.

It then compares this to the lifetime annuity of £6,739 the person could have bought at the outset. Assuming the person lives to age 87 – the average male life expectancy – this annuity would have provided them with a total retirement income worth £148,258.

The following comparisons are based on someone receiving a five-year fixed-term annuity rate of £6,797. This was the highest fixed-term rate available on 1 January 2008.

If the person was healthy at the end of the term they would have been able to buy a lifetime annuity worth £5,153 a year on 1 January 2013, meaning their total retirement income if they die at age 87 would be £121,586. This is 18 per cent lower than if they had bought a lifetime annuity in 2008.

If the person had a mild impairment at the end of the term, such as high cholesterol or high blood pressure, they would have been able to buy an enhanced annuity worth £5,205, giving them a total retirement income of £122,470 at age 87 – some 17.4 per cent lower than if they bought a lifetime annuity at the outset.

Even someone who developed a more serious impairment, such as obesity or sleep apnoea, would receive 7.5 per cent less retirement income overall if they had bought a fixed-term annuity in 2008.

Only those who developed a severe impairment during their five year term, such as lung cancer which spreads to other organs, would have been better off buying a fixed-term annuity. Even then the individual would only receive 0.6 per cent extra retirement income, or £778 over their lifetime, compared with a standard lifetime annuity.

MGM Advantage pensions technical director Andy Tully says: “This shows that a fixed-term annuity is by no means a no-risk product.

“If investment returns are low, as has been the case over the past five years, then you could end up walking into a lower income than you could have got at the outset.

“Even if your health gets worse you could still be much worse off.”

A number of firms, including LV=, Just Retirement and Aviva offer fixed term annuities, although Metlife pulled out of the sector last year blaming historically low interest rates.

LV= head of retirement propositions Philip Brown says: “Flexibility comes at a cost and customers need to understand that. There has been a downward trend in annuity rates over the past five years which has clearly impacted on peoples’ outcomes.

“Break clauses are a very good recent development and allowing customers to change the product at a time that is right for them is a critical benefit.”

An Aviva spokeswoman says: “Fixed term annuities offer a number of advantages. By investing for a fixed period of time, customers know they will have the chance to reconsider their financial needs and requirements in the future, and make a further decision on how to best use their pension fund at that point. It’s a happy medium that’s suitable for those customers who want some increased flexibility.”

“We know through our customer research and regular retirement reports that the retirement market is changing rapidly. No two people are alike and individuals are approaching retirement with very different ideas about how they’d like to spend their life after work. Such products offer an increased choice and flexibility to customers.”

Forty Two Wealth Management partner Alan Dick says: “The fixed-term annuity seems to be the worst of both worlds. It has all the negatives of an annuity without offering the complete flexibility of drawdown.”

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Comments

There are 3 comments at the moment, we would love to hear your opinion too.

  1. Subjective – run the comparisons from now and report in 5 years

  2. This article is flawed in a number of ways. Firstly, there wasn’t a competitive fixed term annuity market in 2008, and rates have sharpened up a lot since then.

    Secondly, annuity rates have collapsed in the last 5 years. Yes, this means that many customers may have been better off buying their annuity when rates were high, but the same can be said of Drawdown. The fact that markets have moved against clients does not necessarily indicate a flaw in the products design, as long of these risks were clearly highlighted.

    Finally, if a client ulitmately bought a single life annuity rather than a joint life one, this could increase their income by a further 20%.

    I think a more balanced article would have been more useful for advisers, and I am disappointed that the providers given the opportuinty to comment weren’t able to provide this balance.

  3. Interesting article which seems to have one provider throwing some mud, who doesn’t sell a fixed term annuity, and those that do, offering little defense. The difficulty is that a fixed term annuity effectively defers risk to the end with very little opportunity to predict the outcome. A number of negative things have to happen for their situation to be a benefit (health, circumstances) against a slim chance of improved annuity rates

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