Avoid this 'solution' for disappointing pensions

PensionsA big player has pulled out of the fixed term annuity market. That's another reason to avoid this flexible pension product.

You probably know that annuity rates have fallen to ridiculously low levels in recent years. As a result, many people have been very disappointed by their pension incomes when they retire.

Some providers have highlighted fixed term annuities as a potential solution to this problem.

That's because fixed term annuities – also known as temporary annuities - are more flexible than conventional annuities.

With a conventional annuity, you make a one-off purchase and you're then stuck with it for the rest of your life.

So if you've used your £100,000 pension pot to buy an annual income of £6000 a year, you can't change your mind later. You'll just carry on receiving £6000 a year for the rest of your life. That could be very frustrating if annuity rates rise after your purchase - you would then see younger retirees getting much better deals than you got for yourself.

If you buy a fixed-term annuity, you use some of your pension pot to buy an income for the next five or ten years. When that period ends, you'll probably then use the remainder of your pot to purchase a conventional annuity for the rest of your life.

Hopefully, annuity rates will have risen once five or ten years has passed, and, of course, you'll also be older by then. So that should mean you'll get a higher income from your conventional annuity at that point. And if your health declined during the time you had a fixed term annuity, that would deliver a further boost to your income.

That's the theory anyway.

The reality is that fixed term annuities haven't worked out well for many of the people who have bought them.

You might have bought a fixed term annuity five years ago in the hope that annuity rates would have risen by now, but they haven't. In fact, rates have just carried on falling. So you won't have gained by delaying your main annuity purchase.

The only exception to this is if your health has seriously declined. If that has happened, you could now buy an enhanced annuity for the rest of your life at a significantly higher rate than what you could get ordinarily.

Going forward, I expect annuity rates to fall further – at least in the short-term. Further out, annuity rates will probably start to rise at some point, but that could be as much as ten years away. Or even longer.

So if you're going to retire soon, and you're thinking about buying an annuity, should you go for a fixed-term version? Personally, I think you shouldn't. Here are five reasons why:

1. Don't fix when rates are falling

There's no certainty about when annuity rates will stop falling. I don't think it's prudent to fix when rates will probably fall further.

2. A big player has withdrawn from the market
A firm called MetLife has been one of the main providers of fixed term annuities, but this month it announced it's withdrawing from the market. It's worried that it can't just deliver a big enough return for new customers.

This means there isn't much competition left in the fixed term market, and that can't be good news for consumers.

3. Cashflow problem
Currently the best level lifetime annuity for a 65-year old male with a £100,000 pot is £5,831 a year. If that man buys a five-year fixed rate annuity instead, he'll receive £5,225 a year. That's a £3030 deficit.

Realistically, the man can only make up that deficit if he leaves to a very great age or if his health declines. As Bob Bullivant of Annuity Direct said to me: "You are almost relying on poor health!"

4. Not the right time for risk
If you buy a fixed-term annuity, you're taking a risk that may or may not come off. Annuity rates may fall, or they may rise.

Now risk can be your friend, especially when you're young. If you take some risk with your investments when you're in your 30s, you may get higher returns and end up richer when you come to retire. And if your risky investments don't all work out, you'll still have plenty of time to recover and make up your losses through further saving.

But taking significant risks in your 60s isn't so prudent. You'll be stuck with a smaller pension and there will be no way to rectify the situation.

5. Potential misselling
John Pollock of Legal & General told Money Marketing he had "deep concerns" that fixed-term annuities may be being missold to consumers who aren't aware of the risks involved.

I wouldn't be surprised if Pollock is proved right and misselling problems do emerge at some point.

So now I've outlined five reasons to steer clear of these products, make sure you follow my advice!

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