019 | A practical guide to advising on fixed-term annuities

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  • David Taylor, Business Devlopment Manager, JustRetirement

Learning outcomes:

  1. Have a clearer understanding of the factors to be considered in the discovery process
  2. Better understand the circumstances where fixed term annuity fits into the retirement planning landscape
  3. Identify the type of clients for whom fixed-term annuity night find and those for whom it wouldn’t fit


Learning outcomes: 1. Have a clearer understanding of the factors to be considered in the discovery process 2. Better understand the circumstances where fixed term annuity fits into the retirement planning landscape 3. Identify the type of clients for whom fixed-term annuity night find and those for whom it wouldn’t fit. Tutor: David Taylor, Business Devlopment Manager, JustRetirement Demographics and fixed term annuities PRESENTER: So can you touch on why this needs to be a consideration for advisers? DAVID TAYLOR: Yes, there are a number of reasons as to why fixed-term annuities should be a consideration, but this slide represents perhaps the most fundamental. Average life expectancy for a male aged 65 in the UK is 18 years. For females, it’s slightly longer at 20 years. So it’s worth considering just how much a client’s circumstances could change in that period of time. There is still huge scope for change even if clients had slightly less than 18 years life expectancy and for those clients who have a greater than average life expectancy, 20, 25 or even 30 years, then there’s even greater scope for changes in their circumstances. And whilst many clients value the certainty payment a lifetime annuity offers, it will be remiss not to even consider how things might change in the future. There are of course regional variations and the slideshows that in some areas, the darker coloured ones, average life expectancy for a 65-year-old is even greater than 18 years. So with the considerable potential change in clients’ circumstances then options that hold open clients future choices, like a fixed-term annuity, must be considered. We mentioned average life expectancy to be 18 years. So for clients who are healthy, so not having any lifestyle factors or medical conditions that would qualify them for an enhanced annuity, then fixed-term annuity would perhaps warrant more consideration as a retirement income option. In addition, where an adviser has remained independent, they should be considering and ruling in or ruling out all of the retirement income options. On the basis that the majority are still independent this means they should consider all the relevant options. People, specifically clients, don’t know what they don’t know, and to avoid the potential for future challenges from either the regulator or their client it may prove beneficial that they can demonstrate how they have provided a comprehensive and fair analysis of the relevant market. Often this will mean considering and recommending not just one, but a blend or combination of different products. For example, why should everyone who doesn’t yet qualify for an enhanced rate be prevented from accessing an enhanced rate in the future, and why would everyone want to sign away their right to any form of future flexibility. Retirement income options available in the market PRESENTER: So what are the relevant retirement income options here? DAVID TAYLOR: There are four broad options for clients to consider, which is considerably more than there were when the open market option was introduced back in 1978; back then there was one, standard annuity. They range from conventional annuity solutions which may be either on standard or enhanced terms to drawdown solutions. Conventional annuity offers certainly in terms of return, but has no flexibility once it is set up, whilst drawdown has a lot of flexibility, but normally carries with it investment performance risk. Investments can of course go up or down, so overall the return is less certain. In the middle we have other options: fixed-term annuity, which offers future flexibility, but less so than drawdown, but without carrying either investment performance risk or the opportunity for growth. There are also asset-backed annuities which offer more flexibility than conventional solutions, though not as much as either drawdown or fixed term annuity. Asset-backed annuities do offer the potential for investment and income growth, but again they’ll carry some investment performance risk, though certain guarantees in them mean that they wouldn’t carry as much risk as drawdown. It’s the adviser’s role with their considerable knowledge and experience to help the client rule in or rule out these options. PRESENTER: So should fixed-term annuity form part of a client’s overall retirement income portfolio? DAVID TAYLOR: Well it would depend. I think it should be more of a question as to where and when does fixed-term annuity fit the needs of clients. Often clients appear to fit into either conventional annuity or drawdown solutions, though it’s important to make sure that we don’t suffer from premature evaluation, and that’s where the discovery process comes in. Clients need to feel that the adviser’s focus is 100% on them and they are going to give them the right advice for their specific situation. Most retirement propositions are built on this very premise, clients like the fact that advisers have experience and they want them to apply that experience to their specific issues rather than just making assumptions. The risk of premature evaluation can be mitigated by exploring that part of the fact finding which will increase confidence in the quality of information supporting recommendations that advisers make to clients. The fact find and client attitudes to income PRESENTER: So what does the discovery process sound like? What can an adviser do to discover the optional right combination of options for the client without coming to sort of premature conclusions? DAVID TAYLOR: Advisers specialising in that retirement advice tell us that it’s important to remember that the client doesn’t know what they as the adviser knows. The most important thing they can do is to try and close the gap so the client can come to an informed decision based upon a much wider knowledge of the implications of the decision that they’re making. As a result, they always begin with the key discovery questions before describing any of the options available to the client. And the key trigger questions may sound something like this: how important or relevant are the following statements to you? Are they one very important, two fairly important, three of some importance or four not important at all? In relation to income some statements might be: I want a guaranteed income for life that will never fall, but also I accept that this will mean that my income will never increase or be able to take account of my change in circumstances or the rise in cost of living; I want as much income as possible in the earlier years of my retirement and I’m prepared to accept less income in later years as a result; I want to be able to secure an income that increases in line with inflation, but accept that the starting income will be much lower because of this; I want to be able to review my decision and to be able to change it in the future whilst accepting that I won’t know what my future income would be until that point; I want to be able to change the amount of income I take in the future, but accept that the amount of income I will be able to take will be unknown until that point. The key issues here are certainty of income, increasing income and reviewing income needs. But of course retirement decisions aren’t just about income, they also have to take into account other needs and objectives. Primarily for most clients these will be around investment control, having flexibility and leaving a legacy. PRESENTER: So what sort of questions might they be? DAVID TAYLOR: Well, when it comes to control over investment decisions, protection for family, dependants and against inflation, another set of questions might be: I want to take account of my change in circumstances such as no longer having to provide an income for my spouse or partner if they die before me; I want to be able to pass on a lump sum death benefit to my family; I want to be able to guarantee income payments continuing for a period after my death; I want to be able to review my protection decisions and to be able to change them in the future whilst accepting that I will not know what either my income will be or what pension legislation may be in force until that time; I want to be able to grow the value of my pension fund and the potential income it may produce, but also accept that the value may fall and the income payable may fall; I want to retain control over my pension fund until my death so that I can pass on as much as possible to my family, but I accept that I will have no certainty as to how much this amount may be as it will depend on the amount of income taken, the investment returns achieved and the legal framework that my pension is subject to in the future. Key issues being considered here are control of capital and the need for death benefits, so it might look a little like this. The answers to these questions help advisers discuss the implications of the clients’ responses. They can then use this information to explain the pros and cons of the retirement income options available to them. It should then become very clear as to whether some of the retirement income options can then be ruled out, such as income drawdown or a conventional annuity. This leads to an informed debate and the client now has a much clearer understanding of their options and the implications of these options. There can never be a perfect solution, but it should be possible to avoid the trap of failing to rule in or out the relevant options which could well be a combination of retirement income products. Fixed-term annuities – what they are and how they work PRESENTER: But moving on to look at where a fixed-term annuity might fit in the process, let’s take a step back, what is a fixed term annuity, how does it work? DAVID TAYLOR: Well I guess the first thing to point is that it isn’t an annuity, but is in fact written under cap drawdown rules and can accept a crystallised or uncrystallised transfer, though not an open market option. It offers a guaranteed income for a fixed term, though this is subject to GAD limits and could possibly change at the review date which is every three years like other cap drawdown schemes. The provider guarantees the income, but if GAD limits are changed there may be a reduction in the amount of income allowed. It wouldn’t go up. However if the income did have to be reduced then it would be returned to the client at the end in the shape of the maturity amount, which I’ll cover in a moment. Clients can select a term which is generally between 5 and 15 years. Fixed-term annuity offers a selection of death benefits some of which are the same as can be achieved with a lifetime annuity. At the end of the term there’ll be a guaranteed maturity amount which will be known at outset. This will not be less than stated at outset if the plan runs full term, but it would be more if the client’s income had been reduced midterm due to a change in GAD limits. The client has the option at maturity to invest in any appropriate retirement income product – we’ll cover this a little more later. So at outset the client will select the level of income they require within GAD limits. The lower the level of income then the higher the guaranteed maturity amount at the end would be and of course vice versa. At the end of the term the client can review their retirement income options again and select those which are most suitable at that time. So at the end of the term the client could go into a conventional annuity either on standard terms or enhanced terms if they then qualified. They might choose to go into another fixed-term annuity or asset-backed or other drawdown solution or in fact any appropriate retirement income product. There may be new solutions developed which might offer options that are attractive to clients at that point. Circumstances in which fixed term annuities could be appropriate PRESENTER: For whom might fixed-term annuity be the right option? DAVID TAYLOR: There’s been a lot of talk about whether fixed-term annuity offers value to a client. What is the relative attractiveness of a fixed-term annuity compared with a standard rate annuity, will it turn out to have been good value. To prove good value from fixed-term annuity or indeed any annuity deferral strategy one has to make so many assumptions about the future that it’s virtually impossible. We have no idea whether they are valid assumptions until after the event. So in this context it’s important to bear in mind that most fixed-term annuities are not designed to be an investment product but a holding vehicle. It’s less about how much or little the overall return is and more about being able to keep the client options open and not fully commit to one shape of income or benefits for life. What we can do is concentrate on the circumstances which would result in the fixed-term annuity being an appropriate recommendation. PRESENTER: So what are those circumstances? DAVID TAYLOR: Here is our client with their fixed-term annuity and at the end of the term a range of options in terms of what they could do with the guaranteed maturity amount, which will be to buy an annuity, buy another fixed-term annuity, buy an asset-backed annuity or go into drawdown or go into another appropriate vehicle which might be developed in the meantime. However, what could happen during or at the end of the term? Let’s look at the situations where fixed-term annuity may prove to be a good decision. We’ll assume people buy a fixed-term annuity with the appropriate benefit options to cater for all of them. In the case of Just Retirement’s fixed-term annuity that would be our plan protection option. So if your spouse or partner dies before you or if you split up with your spouse or partner in both cases you won’t have thrown away money on benefits you’re no longer going to use. If you die during the term the death benefits are much more flexible than a guaranteed period on an annuity. If you live to the end of the term and the annuity rate you can secure gives you a better overall deal than you would have received by buying an annuity at outset. If you live to the end of the term and then qualify for an enhanced rate that gives you a better overall deal than you would have received by buying at outset. If both annuity rates have increased and you qualify for an enhanced rate. If you go on to qualify for an attractive enhanced rate during the term and convert from a fixed-term annuity into an enhanced annuity. The flipside of this is that fixed-term annuity may not prove to have been a better decision than buying a standard rate annuity or alternative retirement income plan if annuity rates at maturity are lower, but it has definitely delivered value by enabling the client to keep their options open and retain much stronger death benefits. Fixed-term annuity will always deliver on the concept of acting as a holding vehicle that keeps options open to those who otherwise would have purchased a standard rate. It’s worth considering this question: if my client did go on to experience one of the situations we’ve just looked at and I hadn’t explored a fixed-term annuity option would my client believe that they had been given advice that is based on a comprehensive and fair analysis of the relevant market and unbiased and unrestricted? Possibly not, and that’s why a fixed-term annuity should be considered and then rule it in or rule it out, but not dismissed without due consideration. Examples of how fixed term annuities can help clients in retirement PRESENTER: But looking more specifically can you share an example? DAVID TAYLOR: Yes, let’s look at an example of a client we’ll call David who is 63. He’s managed to accumulate £50,000 in joint savings along with £150,000 in pension funds. He’s already in receipt of an existing lifetime annuity that pays him around £10,000 per annum, which David took out a few years ago. David’s now stopped work as he wants to enjoy his retirement whilst he’s still healthy and he’s looking to take his retirement benefits. He has a cautious outlook on investments now he is retired and doesn’t want to use income drawdown. He is concerned however about placing all of his funds into one lifetime annuity, as well as being worried about what happens to the funds when he dies. Having met with his financial intermediary David takes his advice and decides that after taking pension commencement lump sum to invest half into a traditional lifetime annuity using the open market option and half into a fixed-term annuity with a ten-year term and plan protection with Just Retirement. This provides him with a guaranteed income whilst investing the tax free cash into savings. It also satisfies David’s requirements that should his health take a turn for the worse he’ll be able to convert his fixed-term annuity into an enhanced lifetime annuity. In addition, he can maintain some control over what happens to his fixed-term annuity funds in the event of his death. Another example could be Stuart who is 55 and his wife Jennifer aged 60. They’re looking to help their daughter with her house deposit. Stuart has several pension funds that he’s accumulated over his working life so far, including a frozen final salary scheme and a couple of personal pension plans. Although they have equity tied up in their property they don’t have much in the way of savings. Having taken advice from his financial intermediary Stuart acts upon this advice and decides that he is going to use one of his standalone personal pensions of £80,000 in order to release the tax-free cash. As Stuart approaches his anticipated retirement age of 65 he decides against income drawdown as he doesn’t want the risk of market volatility. Instead Stuart chooses a fixed-term annuity and takes the maximum tax-free cash available. As he is still earning a salary and therefore does not need the additional income it enables him to set the income level to zero with a term of ten years and plan protection. He understands that he can then make a further decision when the plan matures in line with the rest of his pensions. However, he knows that he has the reassurance of the conversion feature, which enables him to convert to another plan during the term for any reason that is deemed suitable by him and his financial intermediary. The final example we’ll look at is Jeremy aged 59, who has recently received the unfortunate news that his father now in his 80s has had a fall. As a result he decides that he needs to spend more time looking after his father. Jeremy decides to reduce his working hours from five days a week to three days a week. He chooses to use one of the two pensions that he has accumulated to make up the difference. His company pension was set to run until aged 65. So having spoken to his financial intermediary he acts on his advice to use his personal pension of £102,500 to purchase a fixed-term annuity with plan protection. This allows Jeremy to defer making the final decision on the shape of his retirement income and not to expose his funds to investment performance risk during the term until he gives up work completely. His previous salary was £2,000 per month. Now that he’s reduced his working week his new salary is £1,200 per month. Jeremy was able to use the tax-free cash to repay the remainder of his mortgage, which in turn reduced his outgoings by £400 a month. He is also able to use the income from the fixed-term annuity to increase his income back up to £1,500 a month, which helps to cover some of the additional costs involved in looking after his father. PRESENTER: So can you just summarise down some of those scenarios? DAVID TAYLOR: Yes, looking at client scenarios here are six where fixed-term annuity might fit in. Firstly, the young retired, so we’ve got people in their late 50s and early 60s, but they feel it’s too early to commit to a single shape of income. Clients in good health, so where they’re currently in good health, but believe that their health may deteriorate in the future, perhaps based on family medical history, and then that might qualify them later for an enhanced annuity. If we look at the progressive enhanced, we would say enhanced lifetime annuities should always be considered first, but if a client’s condition is mild and likely to deteriorate in the future or other conditions may arise they may want to consider the timing of their ultimate decision. Annuity sceptic, where people feel annuity rates are at an all-time low and represent poor value. They may well live for 25 to 30 years in retirement and want more options. Blended income solution where people like the idea of different retirement income solutions such as a blend of lifetime annuity to provide a level of income as underpin with fixed-term annuity or investment backed annuity. Here people are looking for a flexibility that can’t be achieved with one retirement income product. And then finally I guess we’ve got the lucky few where people have a final salary pension in payment which also provides the guaranteed underpin. They’re looking for options on what to do with any additional pension benefits. Looking at specific financial needs the categories might be tax-free cash release where clients only want to release some tax-free cash, maybe looking to pay off some remaining debts such as a mortgage, or for things like family weddings and they don’t need to take any income at the moment. Death benefits clients who want to maintain a choice of death benefit options, but with no investment performance risk during the selected term, provided of course it’s held to maturity. Major priority here is often to look after their spouse or partner as the ultimate beneficiary of their pension fund. Phasing, the semi retiring, winding down, so clients who are winding down, staying active, perhaps working part time, they’ve got a reduced salary and want to make up the difference. Fixed term annuity provides a guaranteed maturity amount that can be timed to their actual retirement and offers conversion flexibility should their retirement date change dramatically. Drawdown customers at review, an income drawdown customer who is now more cautious following a review and is looking to balance income needs between full drawdown and a simplified avoidance of investment performance risk approach offered by fixed term annuity. Drawdown exit, clients looking to exit income drawdown either on a phased basis or completely, but they don’t want to lock into a lifetime annuity rate currently. Examples of when a fixed-term annuity isn’t suitable for a client PRESENTER: But fixed-term annuity isn’t suitable for everyone is it? DAVID TAYLOR: That’s right. Let’s have a look at a case study example and some circumstances where it probably wouldn’t be appropriate. So here we’ve got Alan who’s retired at age 62 having saved a personal pension fund of £50,000. He’s managed to clear his mortgage, but was very concerned about the state of his finances as he was having to dip into his savings more regularly. Alan is now much more cautious towards investment risk and was recently in the process of moving his holdings into cash and fixed deposits. He met with his retirement adviser to look at his pension fund and enquired about lifetime annuity that offered some guarantees, but also some flexibility should he decide to change his mind in the future. Having carefully considered Alan’s situation his adviser discovered that although Alan appeared healthy he qualified for an enhanced lifetime annuity due to his smoking. His adviser recommended that given that this was Alan’s only pension fund and that he could secure an increased annuity income he should buy an enhanced annuity which will provide the guaranteed income that Alan needs. It’s equally as important to highlight those for whom fixed-term annuities probably aren’t suitable, they perhaps only have one source of retirement income or they can already qualify for an interactive enhanced rate or where they want the comfort of taking a once and for all decision about their income and value certainty above future flexibility. The risks of using fixed-term annuities PRESENTER: So there are benefits, but also risks attached to this form of providing income retirement, could you recap them for us? DAVID TAYLOR: Yes. Each client’s different with their own different needs and objectives and of course their own tolerance and capacity for risk and that’ll differ from client to client. Financial intermediaries will need to clearly advise clients on both the benefits and risks of the solutions being recommended, and this is part and parcel of working with the client to ensure that they understand the solution and have both the tolerance and the capacity for the risks associated with it. Looking firstly at the risks for fixed-term annuity, first risk future income. Whilst the maturity amount is guaranteed annuity rates could be higher or lower in the future. This means that the amount of income that could be secured after the maturity date may be higher or lower compared to a lifetime annuity purchase today. A client situation may change after income payments have started, but they can’t change the level of income. If we look at death benefits, if death benefits had not been selected for a dependant and/or beneficiaries on the client’s death or those selected are no longer applicable then nothing further would be paid from the plan. If we look at the conversion value, the conversion value may be less than the guaranteed maturity amount and the original fund value if the conversion feature is exercised early. Inflation, inflation is always a risk and retirement can last for upward of 20 or 30 years. The amount of income taken initially at retirement may seem sufficient, but as time goes on the increased cost of living may start to have a negative impact if the retirement income isn’t able to adjust to change in circumstances. For fixed-term annuities the risk of what future annuity rates may be should be considered. Of course it is impossible to predict what will happen to annuity rates in the future as rates could fall or increase. But if we look at the options, the fixed-term annuity is potentially an appropriate solution for many customers offering more opportunities to be included as part of the retirement income solution because of its greater flexibility. With Just Retirement’s fixed-term annuity it’s possible to convert the plan to an alternative product at any point during the term for any reason if it suits the client’s circumstances and financial advices given and also planned protection was selected at outset. Other fixed-term annuities may have similar options, it’s important to take the time to research how they all work. The conversion feature encourages regular reviews between client and adviser throughout the client’s retirement to discuss change in health, finances and overall financial planning needs. Income needs may change during the plan for a number of reasons. A plan with the conversion feature gives the ability to convert to another appropriate UK retirement income product suitable to a client’s new circumstances if appropriate advice has been obtained. It also allows those customers who do not currently qualify for an enhanced lifetime annuity to defer making a once in a lifetime decision and retain the possibility of purchasing an enhanced lifetime annuity either during the plan or at the end of the plan subject to the appropriate conversion option being available. PRESENTER: David Taylor, thank you. DAVID TAYLOR: Thank you Mark. It is our intention that the information contained within this presentation is accurate. We have taken all reasonable steps to ensure that it is up-to-date and where relevant, reflects the current views of our experts. However, we do not accept any liability for errors or omissions in the information supplied and if you require clarification on anything, our recommendation is that you contact us at the address below for verification. Our Registered Address Just Retirement Limited Vale House, Roebuck Close, Bancroft Road, Reigate, Surrey RH2 7RU. Regulatory Information Just Retirement Limited. Registered Office: Vale House, Roebuck Close, Bancroft Road, Reigate Surrey, RH2 7RU. Registered in England Number 05017193. Just Retirement Limited is authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.