We've tried a test registration of a free domain name with 1&1 and they haven't charged us for any additional years.
There's a one click option to stop the auto-renewal, when you have start paying in Year 2.
Haven't checked, but I am sure you can transfer the domain name out. Otherwise it would violate Nominet's rules.
I agree that they are not the very best registrar based on our past experience with their customer service, but the others are not that much better and one can't complain too much when they are offering a free domain name + free domain name privacy.