|With Profit & Investment (Unit) Linked Annuities|
In addition to the conventional Pension Annuities it is also possible to purchase an Investment Linked or With Profits Pension Annuity. These work on similar principles to those of conventional annuities except the level of income is determined, at least in part, by the performance of the underlying funds, rather than by guarantee at outset. Consequently the level of income will depend upon investment returns.
These link your income directly to the performance of the insurance company's With Profits fund. Typically, your income is made up of two parts
The starting income is based on an "assumed (or anticipated) bonus rate" (ABR) which you choose at the outset from a range set by the insurance company e.g. between 0% (which assumes no bonuses at all) and 5%. If the bonuses announced by the company are higher than the ABR your income increases, if it is lower your income falls. If you were to choose a 0% ABR your starting income will be the minimum and therefore will rise providing a bonus is declared. Your income is unlikely to fall, although it could if the stockmarket performance was very poor over the long term, unless the minimum income was guaranteed.
An element of security is added however, due to the way with profits funds "smooth" returns to reflect the ups and downs of investment markets.
Your income in retirement will be linked directly to the value of an underlying fund of investments. Generally, you can choose the types of fund, for example:
The more risky the underlying fund you choose, the more your retirement income may vary - both up and down.
Your starting income is based on an assumed growth rate (similar to the assumed bonus rate). If the fund grows at the assumed rate, your income stays the same. If growth exceeds the assumed growth rate, your income increases. If growth is less than the assumed rate, your income falls. A few unit-linked annuities let you invest in a 'protected fund' which limits the fall in your income.
Most unit-linked annuities do not guarantee any minimum income. Even if your income is based on an assumed growth rate of 0%, your income could still fall if the underlying investment fund falls.
You should not consider a unit-linked annuity unless you can cope with an income that can swing widely and may fall. You would need a large pension fund or other sources of income (or both) to fall back on.
Unit-linked annuities are higher risk than either conventional or with-profits annuities.
The value of investment and income from them may go down. You may not get back the original amount invested.
Jonathan is the director and joint owner of the Pension Drawdown Company.