Why thinking short-term can boost your pension!
When it comes to buying annuities, many of us are ignorant of the potential benefits of going with a short-term annuity.
Until a few years ago, the only option for those at retirement was to buy an annuity and hope they lived for a very long time. Today there are a variety of options ranging from unsecured pension through to unitised and with-profit annuities, as well as a product that has grown in popularity over the last few years – the short-term annuity.
This was pioneered by a firm called Living Time. Let's take a look at this product in a bit of detail and consider what investors should be thinking about when it comes to short-term annuities.
The product is relatively simple. The pension fund is split into two parts. The first provides a guaranteed income for an agreed number of years and the second returns a guaranteed sum at the end of the chosen period which is used to buy an annuity, purchase a further fixed-term arrangement or transfer to USP.
This tip is absolutely vital to know if you want to make the most of your pension pot at retirement.
The big advantage of the arrangement is that you are keeping your options open – if you buy an annuity you are committing to a rate for life. However, a short-term annuity allows you to come back to the market on a number of occasions. On each occasion your income will be calculated based on rates available at that time – and in the case of an annuity based on health at that time.
And electing for a short-term annuity can end up significantly boosting your retirement income, as you can read about in This pension mistake could destroy your finances.
In effect you are buying income for a set period and then looking at matters again. It will follow that there can be no guarantee that at maturity of the arrangement your income will continue at its current level – it may fall. This is a risk that in my view is not covered as effectively as it might be in marketing literature, and unless you are happy with this possibility the product is not for you.
On the other hand, your health may change during the income period which enables you to qualify for an enhanced or impaired annuity. There may be family factors that make this more likely, or you may smoke or have some other condition that is likely to become worse over time. In this case you may feel that the risk is lessened somewhat.
Related how-to guide
There are a lot of things to think about as you get closer to your retirement. But the early you start to prepare, the better.See the guide
Over the last few years annuity rates have fallen significantly as interest rates have fallen. In addition, the European Union has introduced legislation named Solvency II, which is in the process of taking a further 20% or so off rates. Those who have bought these products in the past are unlikely to be able to maintain their income when the policy ends. However, many commentators are forecasting a rise in interest rates and so now may be the right time to buy a short-term annuity as a hedge against the very low annuity rates we see at the moment.
Please do bear in mind that it is possible to split a fund between short-term and lifetime annuity in order to obtain a spread of risk.
There is one other consideration, which is particularly relevant – there is little competition in this market currently with only two providers, Living Time and LV=. We expect more to come in this year, with Aviva a strong favourite. This would be welcome as it will bring more competition, and most likely better deals for retirees.