With Profits Annuities: Advantages and Disadvantages

Unlike level annuities which are backed by the performance of 15 year gilt yields, with-profits annuities are backed by the performance of the with-profits investment fund with which they are associated. As with all investment linked annuities, with profits annuities incur a level of risk as your income could go up as well as down, something that cannot happen with a standard annuity.  The income you get from a with profits annuity is based on the bonus level declared by the Life Office. At the start of the plan you pick what is known as an Anticipated Bonus Rate (ABR) which can be anything from 0% to 5%. If the bonus level declared by the fund is higher than your ABR then your income will be higher that year. You can potentially receive a greater increase in income in the future by picking a lower ABR, however your starting income will be lower.  A higher ABR means the fund has less of a gap to make up in order to surpass your ABR. However the fund has bigger gap to fall in order for your income to drop if you go for a lower ABR.

Picking a low ABR is seen as less risky, but the potential rewards are also lower. Should you pick a high ABR, then you can only increase your income if the bonus rate is above this level, which would mean you are hedging your chances of a future rise in income against the fund performing well every year.  If you can bear the risk of your income falling then you may want to go for a higher ABR.

Advantages

With-profits annuities are more flexible than level annuities as they allow the retiree to incur an element of risk in exchange for a potentially higher income. If the ABR outstrips inflation it can prove a more beneficial option compared with other annuities such as RPI annuities or escalating annuities.

Disadvantages

The main disadvantage of a with profits annuity is that your income could fall below your starting income if fund performance is poor for several consecutive years. Even if you got the same amount of money each year your income is still in effect falling due to inflation. Some providers offer what are known as Protected Rights benefits which means you can ensure your income never falls below the starting level. As with all investment annuities, with profits annuities require the annuitant to bear a certain level of risk. If you are not financially secure enough to cope with a potentially lower or level income, then you may want to consider other alternatives.