Investment-linked annuities "provide best of both worlds"
Investment-linked annuities "potentially offer the best of both worlds" to retirees looking to maximise income, according to research by MGM Advantage.
The flexible income they offer can initially match or exceed a conventional annuity – which pays the highest starting income of any annuity – and gives the annuitant the potential to protect their income from inflation through returns generated from equities, the firm said.
MGM looked at the returns four different types of annuity product deliver over the long-term. When compared to a conventional annuity, an inflation-linked annuity and an annuity increasing at 3% a year (based on a £100,000 pension pot invested over 22 years), it found that an investment-linked annuity paid the highest starting income at £5,740.
It also paid the highest annual income in year 22 at £7,895 and the highest total income over the 22 years at £145,655.
The next best-performing annuity over 22 years was the conventional annuity, paying income of £126,346, followed by the escalating annuity at 3%, which paid £119,979 over 22 years.
The worst performer was the inflation-linked annuity, paying total income over the 22 years of £101,718.
Explaining its finding, MGM Advantage said that while conventional annuities pay a higher starting income than inflation-linked annuities, over time inflation can erode 50% of purchasing power.
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It added that although inflation-linked or escalation options protect purchasing power from inflation, they offer a much lower starting income than conventional annuities. It also pointed out that the total income over time is also less than conventional annuities, typically between 5% and 24%.
Andrew Tully, pensions technical director, MGM Advantage, said: "With the forecast for inflation to remain above 2%, and possibly above 3% in the short term, people retiring today who need to generate an income should be considering all of their available options. For example, you could secure a base income using a conventional annuity and then invest the balance of your pension in an investment-linked annuity, which provides a hedge against inflation.
"Of course, you need to be comfortable with the level of risk, which is why it pays to do your homework and seek independent financial advice."
Meanwhile, a new non-advised online annuity comparison site called retirementassured.co.uk has launched, enabling those coming up to retirement with pension pots of up to £250,000 to compare annuities from leading providers. A helpline providing quotes and support is also available on 0808 100 1055.
Annuities compared by MGM Advantage
|£100,000 pension pot||Starting Income||Annual income in year 22||Total income over 22 years|
|Escalating annuity @ 3%||£3,929||£7,309||£119,979|
Replaced as the official measure of inflation by the consumer prices index (CPI) in December 2003. Both the Retail Price Index and CPI are attempts to estimate inflation in the UK, but they come up with different values because there are slight differences in what goods and services they cover, and how they are calculated. Unlike the CPI, the RPI includes a measure of housing costs, such as mortgage interest payments, council tax, house depreciation and buildings insurance, so changes in the interest rates affect the RPI. If interest rates are cut, it will reduce mortgage interest payments, so the RPI will fall but not the CPI. The RPI is sometimes referred to as the “headline” rate of inflation and the CPI as the “underlying” rate.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.