With rates for annuities having been falling steadily for well over a decade, the argument in favour of opting for more flexible pension annuities, such as unit linked or with profits annuities, has been growing ever stronger. Whereas conventional annuities focus on corporate bonds and gilt yields, asset backed annuities invest in other, higher risk stock. Rather than take a fixed or escalating annual pension income, an asset backed annuity (such as a with-profits annuity or a unit-linked annuity) allows retirees to invest a portion of their pension pot into an investment fund which is managed by the pension provider. Although with-profits an unit-linked annuities work in different ways, you can in both instances maintain more flexibility over the investment of your money. These are all examples of investment-linked annuities….
With a with-profits annuity, you can stipulate the ABR or Anticipated Bonus Rate allowing you to speculate on how well you think the investments will perform on the stock market. This can vary from 0% to 5%, with higher incomes paid for higher ABR’s. However if the annual bonus (which is dependent on the performance of the investments) does not match your ABR your income is reduced from the previous year.
Unit-linked annuities are another type of asset-backed annuity that allow the annuitant to choose the amount of risk they want to take with regard to investment of their pension pot. The income from the annuity is linked to underlying investments on the stock market. There are three main options here…
-A medium risk managed fund, where the person running the fund will pick a wide scope of investments, thus spreading the risk.
-A higher risk fund, where the fund manager may pick more niche or specific funds to invest in, thus heightening the risk.
-Tracker fund which is considered to be a medium risk option. In this instance the fund will track a particular stock market. These in the main have lower fees than managed funds.
There are also hybrids and variations of these two types of annuity, with different options built into each one. The general premise is the same though, these are an alternative to those who are not happy with just receiving a level or increasing annuity based on bonds and gilt yields.
What are the risks?
Asset backed annuities are riskier than conventional annuities but they are not the only type of risk to be associated with an annuity. Even level annuities are risky because there is the risk of rampant inflation. There is also the risk that you might need more money in the future than you currently derive from a level annuity. So although asset-backed annuities incur more risk, they can generate higher rewards. They are popular with people with larger pension pots, typically over £100,000 and those who can afford to take a punt on the stock market. However with rates being as they are, it is likely they will become more popular as the return from conventional annuities is perceived as being inadequate.