What are ‘third way’ pensions products?

“They generally attempt to deliver some of the flexibility and investment growth that can be achieved via drawdown and some of the security of income that can be achieved by investing in an annuity,” says Andrew Pennie, marketing director of Intelligent Pensions

“Common to third way solutions is some kind of guarantee, whether in the form of a minimum income or a capital lump sum.”

However, with the benefit of guaranteed funds comes a higher cost of paying for it.

Third way solutions cover a multitude of different products and some are written under annuity rules while others are written under drawdown rules.

Mr Pennie suggests this perhaps adds to the confusion of this market and the ‘third way’ label. “Investment linked annuities are written under annuity rules and include with-profit annuities. Variable and FTAs are written under drawdown rules.”

Alan Mellor, managing director at Phillip Bates & Co, proposes that third way products are for people looking to enter or remain in income drawdown for a set period of time but who want the guarantee of a fixed return from their investments.

People who want to defer the purchase of a conventional annuity are also potential candidates.

Third way products, like drawdown, generally require the investor to have an appetite for some investment risk and be in a position to take on that risk, adds Mr Pennie.

“Fixed term annuities do not carry an explicit investment risk but do have an internal rate of return risk or opportunity cost.”

Longer lives and the demand for flexible retirement patterns are not perfectly served via conventional annuities.

Mr Pennie says he particularly sees a place for third way annuity products as a suitable vehicle for ‘annuity drawdown’ – a form of drawdown exit strategy.

Mr Mellor adds that third way products are not for those just looking for investment risk/reward, nor for client looking for secured pension income, as investment returns may be guaranteed but the actual income available will still be at the mercy of the GAD limits.

Well, why not a conventional annuity and full drawdown then?

“Dependant’s benefits cost with a conventional annuity, so a third way would be a good way to guarantee a fixed return and benefit from the death benefits from a fund in income drawdown,” he says.

Mr Pennie adds: “We are more sceptical about the use of third way drawdown solutions, particularly at the point of retirement, and believe with the correct ongoing management and supporting investment strategy, income drawdown will usually deliver a better client outcome.

“However, some clients will genuinely value the peace of mind provided by a guarantee and provided they understand the cost/risk implications of paying for the guarantee, it could be the best solution to meet their needs.”