Annuities invested in a with-profits fund
As the name suggests, these annuities are invested in a with profits fund. This means that annuitants will share in the future investment gains or losses of the fund and therefore their annuity income will increase or decrease in future years depending on bonuses. This is in contrast to standard non-profit annuities where the income is guaranteed but there is no investment growth.
With profit annuities have the normal annuity options, e.g. single or joint life and choice of guaranteed periods and payment frequencies. However instead of being invested in fixed interest, they are invested in a combination of fixed interest, property and equities. With profit annuities are more risky than standard annuity because the level of income may fall in the future.
Anticipated Bonus Rate* (ABR)
One of the most important features of a with-profits annuity is the anticipated bonus rate (ABR). This enables you to estimate how much you think your With-Profits Annuity income will grow each year, and it determines your starting income.
For example if you select a 4% ABR, the starting income will be similar to a standard level annuity. This makes sense because standard annuities are priced in relation to yields on fixed interest and this is currently about 4%. The ABR is effectively the yield on which the WPA is priced. Whereas the yield on the standard annuity is fixed for the term of the annuity, the annual bonuses on WPAs change every year.
This means that if year 2 the declared WPA bonus is higher than the ABR the WPA income will increase, whereas if the bonus is lower the WPA income will fall.
An example will make this clear. Assume a WPA with ABR of 4% pays a starting income of £ 1,000 p.a.
If the year 2 declared bonus is 5% the Year 2 income increases to
| |
£ 1,000 X 1.05 (Declared bonus)
1.04 (ABR)
=
£1,009.62 |
| |
However if the year 2 declared bonus is 3% the Year 2 income decreases to
|
| |
£ 1,000 X 1.03 (Declared bonus)
1.04 (ABR)
=
£ 990.38 |
If you select a low ABR, say 0%, then your starting income would be lower but all bonuses awarded would result in an increase to income.
The rationale for with-profit annuities
- Annuities are a long term investment and so should be invested in real assets such as equities
- In the long term, equities and property should provide an effective hedge against inflation and potential for income growth
- Most people need an income which has the potential to grow in order to meet their ever increasing expenditure and life expectancy but find the cost of inflation linked annuities too expensive.
The risks of with profit annuities
- Future annuity payments will fall if bonuses are lower than expected
- Increases in future life expectancy can be passed on to the policyholder through reductions in future bonuses
With-profits bonuses
The key to understanding how with profit annuities work is
to appreciate the difference between an "anticipated bonus" and
the "declared bonus".
Anticipated Bonus (ABR)
|
|
Declared Bonuses
|
|
The ABR determines the starting income and is used when calculating
how much the income goes up or down at the anniversary of the policy
The higher the ABR, the higher the starting income. An ABR 0f 4%
will currently provide a starting income similar to a
level annuity.
However a high ABR reduces the scope for future income growth as
it is deducted from the annuity each year before applying the new
bonuses
|
|
Declared bonuses are the actual bonuses awarded to with profit policies
each year.
There are two types of bonuses. Regular or reversionary bonuses and
Top up bonuses or terminal bonuses.
A regular bonus is added to the pension each year and the new pension
amount is carried forward each year. If a top up bonus is declared,
it is applied in that year only.
|
