Variable Rate Annuity - What is it?
This is an annuity which is linked to the performance of investments. It is attractive to retirees as it can mean a potential increase in income each year, as the performance of their investment improves. This means your income can grow year on year and help nullify the effects of inflation.
You will still receive some guarantees for your income, but far less than with conventional annuities for example. However to ensure you have guarantees with a variable rate annuity, you will have to pay for them, and the amount you pay will depend on the level of guarantee. This will be reflected in the rate of income. So if you wanted to be protected from inflation and have your annuity linked to the RPI, your starting income may be substantially reduced to allow for this guarantee.
A variable rate annuity will also mean that you will be able to keep your options open, as there could in the future be changes in your needs or those of your partner, children or grand children. If at an early stage in your retirement you need to protect your income level because you have financial dependents, this would mean a lower income than if you were using a conventional annuity. However if circumstances then change, you could then purchase an annuity without insurance, thus increasing your income.
With a variable rate annuity, you also have the opportunity to benefit from the future performance on investments linked to your annuity. Contrast this with a conventional or fixed rate annuity, which results in you being locked-in to the gilt prices at the time you take out the product.
During the recession of the early 1990’s the gilt values fell, which fuelled an increase in people looking for alternatives to conventional annuities. In modern times there are have been a number of “hybrid” type annuities appearing on the market. Although they are still classed as variable rate annuities, they include secure elements which offer a half-way house between a fixed rate and variable rate annuity.
One of the key attractions of investing your retirement savings in a variable annuity or other investment-linked retirement product is the possibility of receiving a comparable income at the outset, with the potential for income increases to combat the effects of inflation and the opportunity of ‘real’ growth.
With variable annuities, you still receive some income guarantees, but these provide less protection than the guarantees of conventional annuities. Guarantees cost money to provide, so the more guarantees included, or the higher their level, the more the cost. With annuities, this cost can be seen in the rate of income on offer. For example, to include guaranteed protection from inflation (linking conventional annuity payments to the Retail Price Index) will reduce the starting income substantially.
Keeping your options open also means that as your needs and your dependants’ needs change, your choices can be changed to reflect your new circumstances. For example, at an early age of say 60 you may need to include protection for a financial dependant, which if bought via a conventional annuity would mean a lower income for yourself. But, if later in life you no longer need to include this protection, you can buy your annuity without the insurance, which then provides a higher income.
Please note that some changes to the basis of income payments may not be available or may be subject to qualification.
Variable products also provide investment growth potential. Choosing a conventional annuity essentially means you are locking into today’s gilt yields – this underpins the guaranteed income, but it also means you cannot participate in any possible growth.
Fuelled by falling annuity rates (principally due to lower gilt yields), alternatives to conventional annuities have been available since the early 1990s.
Their popularity rose slowly in the early years. But, with growing market innovation and the advent of Income Drawdown in 1995, the number of people buying them increased. This trend continued until the early 2000s when the severe stock market falls were probably the cause of a fall in popularity.
More recently we have seen the introduction of ‘third way’ annuities to the market. This new breed of variable annuity seeks to provide an element of secured income from an annuity, combined with some of the flexibility of an Unsecured Pension (income drawdown). These products vary widely in their mechanics, and new providers are coming into the market all the time.
Advantages of a Flexible Annuity
A flexible annuity combines the advantages of an income for life with the advantages of investing in the stock market. Most flexible annuities have the following advantages :
- Potential for future income growth
- Important if future income is to maintain its spending powerIncome flexibility
- Income can be taken within limits and may be changed from time to time
- Income guarantees
- Normally there is an option for a minimum level of income to be guaranteed
- Control over investments (except with-profits)
- There is a wide range of investment options to suit your attitude and capacity for risk
- Choice of death benefits
The normal annuity options for joint life income, income guarantee periods and value protection are available. Collectively these annuities are also known as’Investment Linked Annuities’ or ‘Asset Backed Annuities’. The most well known annuity in this group is the ‘With-Profit Annuity’ which as its name suggests is invested in a with-profits fund. Included in this group is the ‘Fixed Term Annuity’.
Flexible Annuities give you to greater control over your annuityWhen a traditional (non-profit) annuity is set up, the options selected cannot be changed a later date even if the circumstances change. For instance if it is a joint life annuity and the partner dies first the annuity cannot be re-priced to reflect the higher rates for a single life annuity. Or if your circumstances changed and you wished to alter the level of income, you cannot change your income.However a Flexible annuity gives you income flexibility, investment control and choice of death benefits.
Disadvantages of Flexible Annuity
Here are some of the disadvantages of Flexible Annuities:
- Future annuity payments may be lower than expected if investment returns are lower than projected
- Increases in future life expectancy can be passed on to the policyholder through changes to survivor bonuses
- Investment returns and survivor bonuses may not be sufficiently high to compensate for mortality drag
The income from a Flexible Annuity is not guaranteed and may fall as well as rise. This means that they are more risky than standard annuities
Past performance is no guide to the future
They are suitable for those who are attracted to the concept of annuities but want to invest in equities and are prepared to accept the higher risk in return for the opportunity for future income growth. Flexible annuities are suitable to those who want greater control over their annuities.
Advantages: Flexibility of income, investment control and better death benefits.
Disadvantages: The principle risk is investment risk, but the potentially reduced mortality cross subsidy and higher charges should also be taken into consideration.