Answer: It used to be that retirees with money purchase pension funds could only buy a lifetime annuity, paying them an annual income for the rest of their lives. Around 90% of money purchase pension retirees still do this, even though in 1995 income drawdown was introduced, allowing individuals to draw an income from their retirement pot. The big risk here is investment performance & the prospect that funds could run out while the retiree is still alive, so income drawdown is generally seen as something for those with bigger pension pots.

Now, more annuity options are joining the two extremes of either buying an income for life or living off your pension fund. Fixed-term annuities are one such product, paying a known income for a specific period which is set at the outset & can range from five years minimum up to age 75 as the maximum. A guaranteed maturity amount & a range of possible death benefits are also included.

The great benefit of fixed-term annuities is that they can give more flexibility & choice, allowing the retiree to change their income received during retirement. This is particularly important when two important themes of a modern retirement are considered; the greater longevity of today’s retirees & the changes in expenditure experienced by most retirees during their retirement.

On the first point, it is no secret that we are seeing longevity rise significantly. In 1956, the average man could expect to live another 12 years if he retired at 65, while this figure was 15 for the average woman. By 2006, the respective life expectancy for a 65-year old man was 20 years & 23 years for the average 65-year old woman.

As a result of this increase, lifetime annuity rates available at 65 will be lower, notwithstanding the impact of inflation & interest rates. As a result of this, many retirees in their sixties face low lifetime annuity rates in historical terms. Allied to this is the changing pattern of expenditure over a typical retirement. In most cases, people retiring in their sixties are far healthier & more active than their predecessors, leading to high expenditure early on in retirement. Frequent holidays, perhaps travel to see grandchildren, hobbies & retaining their existing property may all be reasons for high expenditure.

At the same time, it is frequently the case for at least one parent of a retiree to still be alive & an inheritance might crystallise in the first half of their retirement. So the retiree wants to drawdown more pension income in their early years to maintain their current lifestyle, as they know they will be receiving monies from their parent’s estate at some point. Conversely, during the early years of retirement, some retirees will want less income as they continue in part-time employment. Then, as retirees grow older, their lives slow down & spending also falls. This stage of retirement could be called ‘the gardening phase’ as retirees enjoy a quieter life with low expenditure. A final stage for some of prolonged ill-health & long-term care will cause expenditure to rise again & in some cases equity release may be required to fund this period.

Looking at this pattern of expenditure in retirement, it is clear that a standard lifetime annuity, paying a flat rate income, or a rate increasing in line with inflation, may not suit retirees’ spending patterns. In these circumstances, buying a fixed-term annuity is a way of keeping your options open & avoiding the irrevocable commitment of a lifetime annuity until it is necessary.

A retiree in their early sixties can purchase a fixed-term annuity with a guaranteed maturity amount & then in their late sixties look again at annuity rates & consider their position. They, with the help of their financial adviser, may then decide to lock into a lifetime annuity, or they may prefer to purchase another fixed-term annuity, keeping their options open again. As their income & spending changes as they grow older, they will be able to review their needs & decide on the most appropriate course of action. Contrast this with a decision made to buy a lifetime annuity early in retirement. Most people opt for the maximum initial income & no inflation linkage. They effectively are committing to a fixed income for the rest of their lives, which is unlikely to match their changing income requirements.

Fixed-term annuities offer benefits set at the outset of the term which are not affected by investment performance. In this way, they can get security similar to a lifetime annuity, but with the ability to keep future options open. Consequently, they offer retirees an invaluable middle ground between a lifetime annuity & income drawdown. As there can be major lifestyle changes between retiring aged 60 to 65 & 75, a greater degree of flexibility & control is very attractive to retirees.

Specialist advice generally becomes necessary in cases where the retirement fund exceeds £200,000.