Annuities refer to any terminating stream of fixed payments over a fixed period of time using monthly payments to savings accounts, mortgage and insurance payments.
Investment annuities
By taking on more risk, investment annuities offer the chance of higher income opportunities in the future. That is, higher incomes than that from level or increasing annuities.Investment-linked annuities can either be with-profits or unit-linked Only investment annuities are linked to the performance of the stockmarket. This makes income unpredictable, much like the weather.
Investment annuities | Disadvantages
- your income will change each year, so it can go up and down;
- income increases are not normally guaranteed
- increases in income size are unpredictable;
- your income may fall.
You should choose level or increasing annuities if the risk of an unpredictable, and maybe decreasing, retirement income concerns you. Investment annuities can incur higher charges than level or increasing annuities. So a percentage of your fund could disappear in charges.
Increasing annuities
Increasing annuities are suitable if you are worried about the effect inflation may have on your retirement income. You can choose to have your income increased each year.
With an increasing annuity you will receive a smaller starting income compared with a level annuity.
An increasing annuity gives you peace of mind knowing the real value of your income is protected. You can either choose a fixed percentage increase each year or you can choose for your income to increase in line with the Retail Prices Index (RPI) which means your income will increase with inflation and will therefore maintain its buying power.
To protect your income from rising prices you have two options::
- increasing or escalating annuities
- RPI-linked annuities.
Escalating annuities The actual rate of inflation doesn’t matter. Escalating annuities give you income which increases usually at a fixed rate from 3% a year.
RPI-linked annuities RPI (Retail Price Index) is the government’s main measure of the rate of inflation. An RPI-linked annuity gives you income which is adjusted each year to match changes in the RPI.
A limited price Indexed annuity (LPI) is one type of price-indexed annuity. The rate of increase is normally limited to 5% a year, so if annual inflation is above 5%, your annual annuity increase will be a maximum of 5%.
The government’s target is to keep inflation down to between 1.5% and 3.5% a year. Inflation has been much lower over the past few years compared to some higher inflation rates experienced in the 1970′s and 1980′s.
Be warned, with an increasing annuity you start off with a lower income than you would get from a level annuity and you should decide whether you believe | -
- You will live long enough to benefit from the protection against inflation offered by an increasing annuity
- If and how you would cope with an income that was falling in buying power each year.
Level annuity
With a You swap a lump sum for a future constant income which pays the same amount of income year after year for the rest of your life.
Level annuities stay constant and do not rise over time. Your income is based on the ‘annuity rate’ and the amount that you have in your pension fund when you want to buy the annuity.
Level annuities are suitable if you want to go for the highest possible income early on in retirement. Level annuities can look good as they pay a higher starting income than other types of annuities.
However, even with low inflation, your annuity income will buy less and less each year because level annuities do not keep up with inflation.
You will find that if you select an income that does not increase, you will generally receive a much higher initial income than an annuity that does increase. However you should bear in mind that over time the real value of your income will be eroded by the effects of inflation.