Should you buy a lifetime annuity?
Is taking out a single pension annuity policy for the entire period of retirement logical? An individual’s income needs will change over time. Fixed-term pension annuities might offer you a more flexible and modern alternative approach.
Maximising income is a huge issue for people reaching retirement. But you should not ignore the need to build in some future-proofing against changing circumstances.
The majority of retirees with private pension funds choose to buy a single-life, level-term lifetime annuity. This provides the highest possible initial pension annuity income but raises concerns that its value is likely to be eroded by inflation and, if the retiree dies, the spouse is left without an income.
You could buy an inflation-linked annuity. But this cuts the initial income available significantly until it is not viable for many with modest pension funds. The break-even point, where the income from an inflation-linked annuity catches up with a level annuity for the same amount, could be 10 years away.
Choosing a single-life pension annuity for married couples could leave a spouse with no income. This would be compounded if the husband has been the main bread-winner and his fund is used to buy the annuity, yet actuarial statistics show the likelihood is that he will die before his wife.
Individuals on the point of retirement do not have to rush into a decision to buy a lifetime annuity and then live with the consequences for the next 20, 30 or 40 years. They should be able to take their time and survey the options, not selecting on income alone but considering the flexibility and benefits of each individual option.
It is no longer true that forgoing the purchase of a lifetime annuity means being left open to investment performance risk and higher costs. A fixed-term annuity offers a retirement income ‘test drive’, providing a secure income during the annuity term and the ability to rethink both income and benefits according to changing circumstances at the end of the plan term.
Using fixed-term annuities in early retirement would allow people to guard against a loss on early death through value protection and then to renew death benefits when they opt for a lifetime annuity at a later date.
Under this approach, purchasing a single life annuity for a couple makes sense. Take an example of Mr and Mrs J who purchase a single life fixed-term pension annuity with value protection. On Mr J’s death before the end of the term, the value protection provides a fund that Mrs J invests in an appropriate pension product to generate an income.
The great advantage of the fixed-term annuity, though, is its inherent flexibility compared with a buy-once lifetime annuity. Taking out a single pension annuity policy for the whole of a modern retirement is rather like newly-weds buying a car and expecting it to suit all the stages of family life.
Purchasing a retirement income is a compromise between maximising income and protecting that income against future events. The open market option focuses primarily on the first of these. But with increasing numbers reaching retirement with sizeable money purchase pension pots that must sustain them for longer periods than ever before (longevity), protection and flexibility should be given a much higher priority.
