A with-profits annuity is an annuity that will tie your annual income into the performance of your pension provider’s with-profits funds. Your retirement income is based on your starting income and bonuses that are paid out annually. These will have lower starting incomes compared to level or conventional annuities. However the lower starting income means there is money available to be invested in the with-profits fund. As mentioned, an additional annual payout is made based on the bonus percentage paid by the fund (which itself is determined by the overall performance). You choose what is known as an Anticipated Bonus Rate (ABR) at the start of the policy. This can be anywhere between 0% and 5%. A zero percentage ABR assumes there will be no bonus at all so any bonus declared will see your income increase.
Should you opt for a low ABR then your starting income will be lower but you can plan for a higher income in the future as the fund has less of a percentage increase to achieve for you to get a higher income. You can also protect yourself against a drop in income as the fund as further to fall behind for you to get a lower annual income. If you opt for a higher ABR your starting income is higher but you can only increase your income if the fund performs very well and pays a bonus above your ABR. As with most options in annuities, it’s horses for courses…if you have the luxury of being able to take a higher risk you could earn a higher reward. Some policies have built in bonus levels so check with with an annuity specialist to see what option is best for you.
By using the Anticipated Bonus Rate (ABR) a With Profits Annuity offers you a much greater level of flexibility compared to a Inflation Proof Annuity or even a Conventional Annuity. You will get higher increases in income in the future when the ABR is lower. You will know that with a With Profits Annuity your income will never fall below a certain amount. In the long run your income could even grow faster than inflation, although this would entirely depend upon the relevant funds’ performance, inflation levels and the ABR rate each year.
With a With profits annuity your income could indeed increase but there is also the danger that it could decrease to a level lower than what you had in the beginning. (although this doesn’t apply to Protected Rights benefits – these cannot fall to a lower level than at the start) Of course with this type of pension annuity there is no guarantee of a rising level of income. There is also little point looking at what has been in the past or what is on the horizon as circumstances can change quickly. If you have other sources of income at retirement and can take the relative risk then this maybe the option to maximise your potential retirement income.