With Profits Annuities
Unlike guaranteed annuities where the fund is invested in gilts and the income level is guaranteed, with profit annuities are available where the future level of annuity income is linked to the performance of a with profits investment fund.
The investment performance of the underlying with profits investment fund is taken into account in the bonuses the annuity provider declares. Provided a pre-determined rate of growth is achieved, income will be higher than under a conventional annuity and could even increase in the future. However, the income will go down possibly, even below the level of conventional annuity, if the required growth rate is not achieved. Hence with profit annuities are inherently more risky than guaranteed annuities, since they depend on future investment returns upon which the bonuses declared by the with profits annuity provider rely.
The rate of increase on your annuity has to be chosen at outset, as well as additional benefits such as indexation or spouse's benefits. You cannot change these options at a later time if your circumstances change. You select an "Anticipated Bonus Rate" (ABR) between 0% and 5%. If the declared bonus rate of the Life Office is higher than your Anticipated Bonus Rate, the income from your with profits annuity will increase in a given year and if lower, it will decrease. The with-profits approach is less volatile than the unit linkedoptions as with-profits is a smoothed investment- actuaries can hold back on bonuses in years of good investment performance and be more generous in bonus rates when performance. In contrast unit linked funds can offer greater potential for a higher income (although they have greater potential for failure as well) by permitting a more aggressive investment strategy.
With profit annuities are a different proposition to other with profits products, because they do not have the market value reduction problems which other investment vehicles, which contain with profit funds have. It has recently been possible to use protected rights funds to purchase with profit annuities.
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With Profits Annuity Fund Asset Allocation
The table below compares the asset allocation of with profit funds used by the leading with profit annuity providers. This can give a good indication of the likelihood of a fund to produce generous bonus rates in the future. Stronger Life Offices with higher solvency margins and lower liabilities can afford to earmark more of their funds into equities, giving the potential for higher long term returns in the future.
With Profits Annuity Past Performance
It is also important to consider past performance of with profits annuities. Life Offices vary considerably when it comes to generosity- holding back on bonuses in years when the underlying assets have performed well and declaring bonuses in years when the invested assets which support the with profits pooled funds have not performed. For more on this, refer to our section entitled with profits annuities past performance.
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Key Features Documents for with profit annuities: