With-Profits Annuities

A with-profits annuity is a type of investment-linked annuity that is tied to the performance of a with-profits investment fund. Your future annuity income depends on the profit level of this fund, which can go up as well as down. Your income (which is paid on an annual basis) is based on the bonus level declared by the Life Office. You pick what is known as an Anticipated Bonus Rate (ABR) when you buy the annuity, which can between 0% and 5%. If the declared bonus rate from the with-profits fund is higher than your stated ABR then your income will increase that year. A lower ABR will mean a lower starting income level but you may see a rise in income in the future as the fund has less of a percentage to make up in order to exceed your ABR. Equally the fund has a greater percentage to fall in order for your income to fall if you pick a low ABR. In this respect picking a lower ABR incurs less risk, but the potential reward is also lower. If you pick a high ABR, such as 5% then your income can only increase if the fund’s declared bonus rate is above this figure, although your starting income will be higher. If you can afford to bear the greater risk of a higher ABR then you have the chance of a higher income.

What are the advantages?

With-profits annuities can be seen as more flexible than conventional annuities as you can opt for the amount of risk to incur in exchange for the chance of an increasing annual income. Another advantage is the peace of mind that your income will never fall below a certain level. Your income level could increase more than if you had opted for other forms of escalation such as an inflation-linked annuity if the ABR outstrips inflation. However in times of recession when the stock market tends to perform badly and there is sluggish economic growth, this may prove unlikely.

What are the disadvantages

Your income level could fall to below your starting income if the with-profits funds perform badly for a consecutive number of years. Remember inflation rises each year so even getting the same income level each year is a ‘real-terms’ cut in spending power. To combat this you can build in what is know as Protected Rights benefits which ensure your income does not fall below the starting level. As with other forms of investment such as unit-linked annuities, with-profits annuities mean the individual is taking on a level of risk in order to potentially get a higher income. If you cannot afford this risk then you would be better suited to a guaranteed or conventional annuity.