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Short Term Annuity

After taking your tax free cash lump sum, your fund is initially divided into two separate elements. The first element will be used to secure a temporary annuity not exceeding five years.

As a temporary annuity costs less to provide than a similar lifetime annuity, the bulk of your fund will be available for investment. The maximum initial income that may be paid by the temporary annuity depends whether the short term annuity is purchased from a drawdown fund subject to the capped or flexible drawdown rules.

Flexible or Capped Drawdown?

Short Term AnnuityIf the annuity is purchased by a drawdown fund subject to the capped drawdown rules then the annuity will be subject to the same rules as capped drawdown in terms of the maximum income that can be taken and the frequency of reviews (three yearly to age 75 and annually thereafter).

If the annuity is purchased from a drawdown fund subject to the flexible drawdown rules then the amount of income is unlimited and no reviews are required.

After the chosen period the temporary annuity will cease and you then have three options with the remaining invested part. You can decide to secure another temporary annuity, use Drawdown Pension (see above) or buy a lifetime annuity/scheme pension (see earlier sections). You may repeat this process over and over again.

Additional pension benefits can be taken before the end of the term of the existing short-term annuity contract. Where Drawdown Pension is used or additional short-term annuity contracts are purchased the level of income already paid, or to be paid, from the existing annuity contract must be taken into account (if subject to the capped drawdown rules) when considering how much additional Drawdown Pension/Short term annuity can be paid or secured. If subject to the flexible drawdown rules, the level of income is unlimited.

As with standard annuities, there is no return on death unless you select an annuity certain (which guarantees payment of the annuity for the term chosen even if you should die sooner) and or a spouse/dependant’s pension. However, this product does allow you to change the spouse/dependant’s pension provisions at each review to reflect changes in your circumstances.

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Advantages

  • Subject to limits imposed by legislation (if capped drawdown rules apply), you will be able to plan in advance the level of income that you wish to take each year, so that you can take into account any other sources of income which may become available to you.

  • You may be able to structure your income to mitigate liability to personal income tax.

  • You receive a guaranteed level of gross income over the term chosen (up to 5 years).

  • Your spouse/dependant(s) can enjoy a guaranteed level of gross income, in the event of your death (if applicable).

  • Your pension can be guaranteed for the full five years (or selected term if less) by choosing an ‘annuity certain’.

  • You will be able to take your full tax free cash lump sum immediately to spend or invest as you wish.

  • The pension fund value (less the amount used to purchase the short-term annuity and associated charges) will continue to be invested for you until you decide to purchase further short-term annuities, a Lifetime Annuity or Drawdown Pension. Depending upon investment returns, which can fall as well as rise and are not guaranteed, this may provide the opportunity to achieve sufficient growth to improve your ultimate benefits when you decide the time is right to purchase a Lifetime Annuity or Drawdown Pension.

  • If you or your spouse is relatively young, a secured pension (lifetime annuity or scheme pension) would be less attractive due to the lower mortality factor and, in addition, there is a longer timescale to take advantage of the potential investment rewards and risks of Drawdown Pension

  • You can delay purchasing a Lifetime Annuity if you think annuity rates will improve.

  • As you get older there is the prospect of annuity rates rising and providing you with higher income. This is because life expectancy is shorter for some one older and it therefore costs less to provide them with the same given level of income than for a younger person, assuming all other things being equal.

  • On death, the remaining pension fund (i.e. the portion that has not been used to purchase short-term annuities or other pension products) can be returned to your beneficiaries, normally free of Inheritance Tax and the 55% income tax charge.

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Disadvantages

  • The level of income is fixed for the term chosen (up to 5 years) and cannot respond to changing personal financial circumstances (although if the maximum level of income is not being taken under capped drawdown, or if flexible drawdown applies, it is possible to purchase an additional short-term annuity or use Drawdown Pension to achieve further income (up to the
    maximum allowed if capped drawdown applies). Alternatively, a lifetime annuity could be purchased with some or all of the remaining pension fund).

  • If using capped drawdown income levels must be reviewed at least every 3 years prior to age 75 and annually thereafter and at a review the level of income will depend upon annuity rates at that time and may be smaller than the income received at outset.

  • The rate of growth needed within the investment element to provide an annuity at the end of the chosen period which is at least equal to the annuity level at outset may not be achieved.

  • In the event of death, benefits for your dependants could be lower than those enjoyed under some of the other options available to you and briefly explained in this guide.

  • Investing in relatively safe areas such as cash and gilts is unlikely to enable a higher lifetime income to be achieved than with a secured pension therefore investing in the type of assets that might achieve the extra returns necessary will involve risk. The shorter the term to the intended date of purchasing a secured pension, the greater the risk.

  • Annuity rates may be at a lower level when annuity purchase takes place and there is no guarantee that your income will be as high as that offered under the other options referred to earlier.

  • There is no guarantee that annuity rates will improve in the future. They could be lower when you decide to purchase your annuity than they are currently. Your pension may be lower than if you bought a lifetime annuity now.

  • The value of your pension fund may go down as well as up and investment returns may be less than those shown in the illustrations.

  • Taking withdrawals (in order to purchase short-term annuities or via Drawdown Pension) may erode the capital value of the fund, especially if investment returns are poor and a high level of income is being taken. This could result in a lower income if/when an annuity is eventually purchased.

  • Using short-term annuities to take high levels of income may not be sustainable in the longer term.

  • In some circumstances, death benefits which are not paid to your spouse or dependants might be liable to Inheritance Tax.

  • Death benefits payable as a lump sum, from the remaining pension fund (i.e. the balance after short-term annuity purchase) are subject to 55% income tax if death occurs after age 75.

  • You may feel the possibility of future higher income does not compensate for the guaranteed level of income available today, and for the rest of your life, that a conventional lifetime annuity provides (although, as mentioned earlier, there are now Drawdown Pension products available which offer a guaranteed level of income regardless of fund performance).

  • Annuity providers make a profit from the fact that some individuals die sooner than is expected. They utilise some of this ‘mortality profit’ to enhance current annuity rates. By delaying the purchase of your lifetime annuity, the benefit of this potential profit, which can be significant, may be lost.

  • If investment returns do not at least match the critical yield (in simple terms, the value of growth required to provide an equivalent income at the age you intend to purchase an annuity) your eventual income is likely to be less than that which could have been available at outset.

Advice Tailored to Your Circumstances

When approaching retirement around 55% of people simply accept the first offer their pensions company sends them. Although it probably doesn’t take into account their health and lifestyle or inflation, that contract is legally binding for the rest of their lives. We don’t think signing it is a smart move. Contact us now for individual advice tailored to your circumstances.