When a person reaches retirement age it is common that they will purchase a pension annuity.  An annuity is used to covert a person’s total pension fund into a regular income that will be paid for the rest of their life.  There are several types of annuity policy available to UK consumers.  One such policy is a With Profits Annuity.

In a regular annuity the pension fund is invested in gilts to provide a guaranteed income.  With profits annuities differ in that the income they provide is linked to the performance of an investment fund.  The success or otherwise of the investment fund is taken into account in the income the annuity provides.  With profits annuities include a pre-determined expected rate of growth for the investment fund.    If the investment performs as well or better than expected then the annuity income will be higher than that of a conventional annuity.  However if the investment doesn’t achieve the required rate of growth then the income it provides could be reduced and may be lower than that of a standard pension annuity.

The decisions the person makes at the beginning of the policy are significant since in most cases then cannot be changed.  At the outset the rate of increase of the annuity must be chosen as well as additional benefits such as spouse’s benefits.  When taking out the policy an Anticipated Bonus Rate (ABR) of between 0% and 5% must be chosen.  If the declared bonus of the annuity provider is higher than the chosen ABR then the annuity income will increase, if it lower then annuity income will decrease.

With profit annuities are inherently more risky than standard annuity policies and so they aren’t suitable for everyone.  People who are risk adverse are likely to be better off considering other types of annuity.