Investment Linked and With Profit Annuities
What are ‘Profit & Investment (Unit) Linked Annuities’?
As well as a ‘Conventional Pension Annuity’ you can also purchase an ‘Investment Linked’ or ‘With Profits’ Pension Annuity. These options operate on similar principles to conventional annuities with the exception that the level of income is partly determined by the performance of the underlying funds, rather than as a guaranteed sum from outset. As a consequence, the level of income received will clearly depend a great deal upon the investment returns.
With Profits Annuities
‘With Profit Annuities’ link your pension income to the performance of the insurance company’s ‘With Profits Fund’. Your income is, generally, made up of two distinct parts:a)
- Minimum starting income
Usually set at a low level this is the “least” income you expect to receive (unless investment conditions are very bad). There are ‘With Profits Annuities’ schemes that guarantee this.
Each year, insurance companies will announce bonuses. These ‘Bonuses’ can be ‘reversionary’ (announced once a year and are guaranteed to pay out for the duration of the annuity) and ‘special’ with new bonus rates being announced each year. Of course, the level of any bonus will depend on more than one factor but the key factor is the performance of the ‘stockmarket’. There are insurance company’s that will guarantee a bonus rate of around 3% a year and you may be allowed to choose the guaranteed rate however, the higher the guarantee, the lower your ‘minimum starting income’.
A ‘minimum starting income’ will be based on an “assumed bonus rate” (ABR) which can be chosen from a range of rates set by the insurance company. For example, from 0% (which assumes no bonuses at all) and 5%.
If the announced bonus is greater than anticipated by the chosen ‘ABR’ your income will be increased. Conversely, if less than anticipated, your income will decrease. Therefore, should you choose an ABR set at 0%, the ‘minimum starting income’ will be set at the lowest level. Therefore the income will be increased as and when a bonus is declared. The chances of your income falling is unlikely, although during extended periods of poor stockmarket performance it could be adversely affected it was not “guaranteed” from the start.
Your retirement income can be directly linked with the value of an underlying fund of investments.
You can choose the type of fund that works for you, for example:
- A medium risk managed fund
A fund manager selects a range of different shares and other investments in order to spread the risk over a wider market.
- High risk fund
A fund manager will select shares and investments based in a particular country (eg, China, India) or in particular sector or with smaller, growing companies or technologies. This practise can yield great results but because your money is more closely invested, the risk is much clearly higher.
- Tracker funds
On the whole, this option is considered to be a medium risk option which tracks the performance of a particular stockmarket index, such as the FTSE-100. Generally this kind of fund carries lower charges than managed funds. Essentially the more risk involved with the chosen underlying fund, the more your retirement income could vary. Starting incomes are based on an ‘assumed growth rate’ (similar the ABR option above). Presuming the fund grows at the “assumed” rate, your income will remain constant. Should the growth exceed the assumed rate, your income will be increased but, of course, if the growth is less than anticipated, again the level of income will fall. However, there are a few unit-linked annuities that allow funds to be invested in a ‘protected fund’ which would limit any fall in your pension income.
In general, unit-linked annuities do not tend to offer a guaranteed minimum income. Assuming your growth rate is set at 0%, you could still see a fall in income if the underlying investment fund is reduced. Essentially you should not choose a ‘unit-linked annuity’ unless you are prepared and can cope with the effects of an income that is unstable and could even be greatly reduced should market forces make adverse effect.
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