Annuities

Annuities are used to provide a pension income that is guaranteed for life. The pension lump sum is exchanged for a pension income. Once the annuity has been bought, the income is fixed, the contract cannot be reversed - the pension lump sum becomes the permanent property of the annuity provider.

The level of income that you will receive from an annuity depends upon several main factors:

• The level of Investment
• Age of 'annuitant'
• Health
• Sex
• The prevailing annuity rates at the point of annuity purchase

In general, the older an annuitant the higher the income which can be secured. Furthermore males usually receive a higher income than females due to generally having a shorter life expectancy.

Annuities can be set up to provide different benefits / options:-

• Spouses pension (to protect a spouse, by providing an income, following the death of the annuitant)
• Guaranteed payment periods; 5 years is typical but 10 year guarantees are possible
• Escalation of benefits; income can be protected from inflation - RPI linked escalation, alternatively a fixed % annual increase in income can be secured at outset eg 5%.
• Annuity income can be linked to investment perfornance for example by a 'With Profit Annuity' or 'Unit Linked Annuity'

Further details can be found under the following headings:

Annuities: The options available

It's important to understand the options available to you when you buy an annuity. Like all things, there are pros and cons to each. Which option suits you depends upon your circumstances and attitude to risk.

Level Annuity
Income will not increase in payment. It provides the annuitant with the highest attainable income from outset compared to other options. However, as time goes by and inflation sets in, the value of the pension, in real terms, decreases. In the case of someone who retires early and then lives a long time, this reduction in 'buying power' could be considerable.

Joint-Life Basis
With this option, either a full or reduced income will continue to be paid to the partner if the annuitant dies. Because women tend to live longer than men, a wife several years younger than her husband could reduce the income payment offered at outset significantly. Joint life annuities are usually taken out by married couples, especially when the spouse has no other independent pension income.

Guaranteed Annuity
It is possible to ensure that the income to be paid is guaranteed at a set level for a period of time even if the annuitant dies early. Typical guarantee periods may be 5 or 10 years. This option will almost certainly reduce the starting income.

If the annuity is on a joint-life basis and both parties die within the guarantee period, the payments will continue to be paid to the deceased annuitants estate.

Escalating Annuity
These provide an income that will increase annually at a predetermined rate, or sometimes in line with the retail price index. The advantage of this is the income provides some protection against inflation. However, the initial starting income will be reduced in comparison to a level annuity.

With or without overlap
Applicable when a joint life guaranteed pension has been chosen. With overlap, the spouse/dependent's pension will commence immediately upon the annuitant's death. Without overlap, the pension will commence at the end of the guaranteed period or immediately upon the annuitant's death, whichever occurs latest.

With profits & unitised Annuities

Traditional annuities provide a guaranteed income; however, there are other types now available, namely with profits & unitised annuities. They differ from traditional types in as much as the guaranteed element is either reduced or taken away altogether in exchange for the possibility of increased income in the long term.

In respect to a with-profits annuity, a low guaranteed income level is initially secured and then an annual bonus is payable from the (linked) with-profits fund. The level of income therefore fluctuates from year to year and is dependent upon the success or otherwise of the With Profits fund.

Under a unit linked annuity, no guarantees are provided. The income received is dependent upon the underlying performance of the linked fund/s, which will undoubtedly fluctuate over time. With favourable market conditions, a unit linked annuity may, in the long term, produce income that exceeds that of a traditional level or escalating annuity. The problem is that the reverse is also true; adverse conditions may seriously affect the value of a pension income.