Pros and cons of different third-way products

Fixed-term annuities and some other products include the option of exiting the product mid-term, albeit for a price, and a nil income option can be elected to allow the fund to grow.

“FTAs allow clients to defer from making the ‘once in a lifetime’ decision about purchasing an annuity and to keep their options open. This could see them avoiding pitfalls e.g. purchasing spousal income or securing a standard terms annuity only to find that their health deteriorates.”

However, Mr Mellor notes that plans, especially FTAs, are fixed at outset and that FTAs can only be purchased with crystallised funds.

Moreover, he argues that not only does the security of return come at a price, but income is still at the mercy of GAD limits and, as with drawdown, re-investment risk is a problem for long term planning.

“Also FSCS [Financial Services Compensation Scheme] cover is limited to 90 per cent, in comparison to deposit accounts third way products would only be more suitable to larger funds, in particular those clients who already have £85,000 with each institution.”

Andrew Pennie, marketing director of Intelligent Pensions, argues that identifying the pros and cons of third-way products is slightly more complex as different providers have different nuances of how their contracts work.

He says, in general terms, other advantages of third way annuity products include:

• Most solutions include benefits of mortality subsidy;

• Cost of guarantees is usually lower than drawdown third-way solutions;

• Flexibility of income within a range; and

• Some third-way annuity products offer enhanced rates.

Mr Pennie questions the additional cost paid for this peace of mind – “is it necessary?” – and also identifies some other disadvantages as:

• No guarantee income will be higher than annuity – now or in future;

• Death benefits are the same as conventional annuities – additional protection comes at a cost; and

• Unable to benefit from change in future circumstance that could improve retirement income e.g. health change or death of spouse.

For third way drawdown products, Mr Pennie identifies some of the same advantages, but also identifies:

• Can allow client to take advantage of improved future annuity rates;

• Benefits from more attractive drawdown death benefits; and

• Flexibility of income within GAD range;

Likewise, he identifies the following disadvantages peculiar to third way drawdown products:

• Internal rate of return on fixed term annuities is poor value;

• There is no mortality subsidy;

• Contract terms can be complex and reduce flexibility to react to client circumstance changes; and

• Lack of flexibility for phasing.