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Understanding Investment-Linked Annuities
Investment-linked annuities put your pension fund into investments, such as stocks and shares. This means you could continue to benefit from rises in stock-market investments after retirement, but there is also the risk that the value of your investments could fall.
Investment-linked annuities can either be:
- with-profits – these link your income directly to the performance of the insurance company’s with-profits fund; or
- unit-linked – these link your income to the funds you invest in.
There will usually be a choice of funds for you to choose from.
Investment annuities usually have higher charges than basic annuities so bear in mind that some of your fund will pay these and annual charges up-front and that this could also reduce your income in retirement. Specialist financial advice should be taken.
The Pros and Cons of an Investment Linked Annuity
Basically, the amount of the payments you will receive depend on the performance of your chosen investment. If the selected investment performs well, you can enjoy higher income payments. On the other hand, if the investment does poorly, you will get lower payments.
Therefore, the main benefit of an investment linked annuity is the chance of a higher income while the downside is unpredictability of the returns which go hand in hand with the unpredictability of the stock market. Also, bear in mind that investment linked annuities usually come with higher charges, though the actual amount depends on the annuity provider.
With-Profit Annuity
There are two basic types of investment linked annuities. The first type is the with-profits annuity or an annuity linked to a with-profits fund.
When getting a with-profit annuity, you have to understand that insurance companies give bonuses each year and the amount of the increase you will get depends on these bonuses, which, in turn, are determined by stock market and other invetment performance.
Before you get this type of annuity, then, you have to choose an assumed bonus rate, or ABR. If the bonus rate of your annuity provider is higher than your selected ABR, you get a higher income, but if it is lower, you will get a lower income. It is normally advisable then to choose a low ABR so that even if you have a low starting income, you can be more certain that it will increase.
Be careful when choosing an ABR, since you will not usually be able to change your choice later on i.e. switch to a higher ABR or a lower ABR.
Unit linked Annuity
The other type of an investment linked annuity is a unit linked annuity. With this, you choose the type of investment fund to link your annuity to. This can be, for example, a medium risk managed fund, which invests in a diversified spread of assets; a higher risk fund or a tracker fund. The higher the risk, the more varied your income is likely to be.
