Short-term Annuity – how does it work?

Understanding short-term annuity products is an important step in planning for your retirement. Let’s look at short-term annuity and it’s pros and cons as a source of income once you retire. 

What is a short-term annuity?

An annuity is a retirement product you can choose to buy with all or part of your pension pot. You might choose a lifetime annuity, which pays you a regular income for the rest of your life, or a short-term annuity which lasts for a fixed number of years. A short-term annuity is also known as a fixed-term annuity. 

If you like the idea of a regular amount of income, but with the flexibility to change your mind later, a short-term annuity could make sense. These income products last between one and 20 years, although people typically choose five or ten years.

How does a short-term annuity work?

With an annuity, you pay a lump sum in return for a regular, guaranteed income. You might choose to receive the income monthly, quarterly or annually. 

The annuity provider will decide how much to offer you depending on various factors including your current age and your health. 

Your provider will invest the money you paid for the annuity at a fixed rate of growth. In addition to the income you receive from the fund, you receive a maturity sum at the end of the annuity period. This is your original investment plus growth, minus the income paid to you. If you choose to have a lower annuity income, you’ll receive a higher maturity amount at the end.

There are certain death benefits with an annuity. If you die before the end of your short-term annuity, a beneficiary of your choice will receive the rest of the money.

How to choose the best type of annuity 

Once you buy an annuity you cannot change your mind, so it must be the right decision for you. Annuities are complex and there are many different things to consider, including taxation, fees and rates as well as the different rules for each individual product. 

It is important to seek professional advice before buying an annuity, as making the wrong choice could mean you miss out on thousands of pounds.

What are the alternatives to buying an annuity? 

An annuity isn’t the only way to gain an income in retirement. Other options include:

• Income drawdown – With this option, you invest your pension fund with a provider that allows you to control how much you take from the pot. You can take an income or choose lump sum withdrawals. You also control how the money is invested, so if you manage your pension wisely, you could increase the size of your fund.

   

• Take a lump sum – Some people choose not to opt for annuity payments. Instead they take a lump sum from their pension pot and use that as an income for a set number of years. The first 25% of your pension can be taken as tax-free cash.

   

• Deferred purchase –  It can make financial sense to wait a few years before buying an annuity. The older you are, the more attractive rates you will be offered by the annuity provider.

   

• Phased retirement – If you are well and enjoy your work, there’s no reason to stop once you reach retirement age. Many people choose to continue working and gradually reduce their working hours. You can buy a financial product called a phased retirement plan, which releases your pension gradually as your working hours decrease. 

Are annuities a good or bad idea?

Annuities have both pros and cons. Their big strength is that they provide you with a guaranteed income and total peace of mind. 

The downside is that the fees can be expensive, and you are likely to get less growth than you might with other investments. Annuities are also short term, so the expensive fees would not apply to a standard term annuity.

What are the rates like?

Annuity rates depend on your age, the provider and the annuity product. But as a very general illustration, if you’re under 70 and buy an annuity for £200,000, you might receive an income worth around £10,000 per year.  This figure is subject to income tax.

How can Spectrum Advice Network help me?

Retirement planning is complex and very important and we strongly recommend that everyone seeks professional financial advice before making any decisions. You can contact us here