Feature Article

Most people will buy a conventional annuity that provides a fixed or increasing income for the rest of their life.

There are alternative annuity products that provide an income for life, but they usually involve some degree of investment risk. In other words, your income may fall in value.

If you’re happy to take some investment risk in return for a potentially higher income, these products could be for you.

There are two main categories of investment linked annuities:

With profits annuities

With profits annuities are invested in the company’s with profits fund. With profits funds generally invest in a mix of assets (including equities). To try and avoid sharp increases or decreases in the value of the fund, one of the distinctive features of with profits is ‘smoothing’. This simply means the insurance company will hold back some of the gains from investment returns in the good years to subsidise returns when investments perform poorly.

Typically, income from a with profits annuity is made up of two parts:

• A minimum starting income. This is set at a low level but, unless investments perform very poorly, you will usually get at least this much income each year.
• Bonuses. The insurance company usually announces bonuses each year. Bonuses can be ‘reversionary’ (this means they are announced annually and guaranteed to pay out for the duration of your annuity) and ‘special’. Special bonuses only pay out a year or so until the next bonus announcement. The amount of any bonus depends on many factors, the most important of which is the performance of the fund.

Some insurance companies may guarantee a bonus rate, for example 3% a year. Sometimes you can choose the guaranteed rate, but the higher the guarantee you choose, the lower your starting income.

Unit linked annuities

With unit linked annuities your income in retirement will be linked directly to the investment performance of the fund you’re chosen. This means your fund value will rise and fall in line with the underlying value of the investments in your fund, unlike with profits funds.

Like with profits, many of these products will provide some form of guarantee so you know, whatever happens to your investments, your income can never fall below a minimum guaranteed level.

Who buys this type of annuity?

Around 3 in every 100 annuities bought each year are investment annuities of one sort or another. The people who are most likely to buy these annuities, are likely to be people who:

• Understand investment risk and appreciate what they’re buying
• Can sleep easily at night knowing that their income could fall
• May have other sources of income in retirement

If you are interested in any of these annuity options you are advised to seek Independent Financial Advice.

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