With Profits Pension Annuity – A valuable alternative!

The With Profits Annuity combines the payment of an income for life with the potential for growth as well as some protection from inflation.

How it works

Your fund will be invested in the insurance companies With Profits fund.
You are asked to set the Assumed Bonus Rate (ABR/BAR) level for a With Profits Pension Annuity. Effectively, you are being asked what bonus do you expect to be declared from the With Profit fund at the end of the year. The normal parameters are between 0% and 5%.
When setting your ABR the company will pay you this bonus in advance, throughout the course of the first year. If at the end of the year the bonus rate declared is the same as your assumption, then for the 2nd year your income will be broadly the same.
If the bonus rate declared at the end of the year is lower, then the company need to recover the additional amount they have paid out and will reduce your 2nd years income. The opposite is that if the bonus is higher than expected then your 2nd years income will increase.
The higher your ABR, the higher your first year's income. Conversely, the lower the ABR, the lower the initial income. However, the lower ABR creates a bigger potential for increases in future years. For example, on a bonus anticipation rate (BAR) of 5% it would give you a high annuity now.
Your income will be linked to the performance and subsequent bonuses declared by the With Profit fund.

You may choose to have a Single Life or a Joint Life annuity - Joint life will provide your partner or spouse the income should you die before them.

Guaranteed period is also one of the options - you can select the annuity to be paid to you and/or your spouse for 5 years or 10 years - irrelevant of what happens to you.

Where will your money be invested?

With Profit annuities are written in the With Profits section of the insurance companies With Profit fund. A typical asset split is:

42% UK Equities
30% Fixed Interest (Government Gilt Edge Stock and Corporate Bonds)
19% Commercial Property and
9% in Overseas Investments

One big advantage of the With Profit annuity is that it can be converted to a 'guaranteed' annuity in the future (once the annuity has been in payment for 12 months, and with the same provider). One would convert if, for example, annuity rates in general rise or to consolidate a period of high bonus payouts.
A positive return has been achieved on the example With Profit annuity even during one of the worst periods in UK investment history! This is partly because all With Profit funds maintain a ‘surplus’ that can be used to subsidise lean times. (The company can dip into a reserve pot to maintain bonuses in periods of poor growth – the ‘smoothing effect’.)
The life expectancy assumptions for With Profit annuities are lower than for conventional guaranteed annuities, which result in a higher income for the same investment return. In other words the rates used for With Profit annuities tend to be better than those used for conventional guaranteed annuities.
One of the main advantages of a With Profit annuity is that it provides the potential to combat the effects of inflation without the associated costs of a conventional annuity. This means that to buy guaranteed increases from a conventional annuity reduces your starting income significantly, and can take a long time before you ‘break even’ when compared to a ‘level – non increasing’ income. The With Profits annuity can provide the same as a level annuity now, with the potential for increases.
Another way of looking at a With Profit annuity is that on retirement it may be reasonable for you to expect to live for another 20 years. If you were investing money over such a long term would you normally want some equity exposure in your portfolio? The With Profit annuity provides this.
The risk is that if the Assumed Bonus Rate you set is not declared in a particular year then you could expect to see your income fall for the next year. However, you set the Assumed Bonus Rate and can be conservative with your assumption, thus reducing the risk.

Minimum pension fund: £20,000 (after taking any tax free cash)

Advantages:

a guarantee income at a certain minimum level
growth potential with Anticipated Bonus Rate (ABR) and inflation (The lower the ABR, the greater the potential for higher increases in the future)
Annual review allows you to convert into a different type of annuity after 12 months
Over the longer term, the potential for growth could keep your income ahead of inflation (depending on fund performance, inflation and the ABR chosen)

Disadvantages:

Although your income has the potential to increase it could also go down or even fall below the amount you started with.
Past performance is no guide to the future so increases to income are not guaranteed.