Annuities turn your pensions into an income to fund your retirement. We explain how investment-linked annuities could offer a better return, if you’re happy to take some risk.
What are investment-linked annuities?
Traditional annuities offer a fixed level of income or a lower starting income that will increase in line with inflation. Annuity rates are linked to yields from government bonds, or gilts, which, despite a recent upturn, are still near all time lows.
Investment-linked annuities are different. They come in two varieties, unit-linked annuities and with-profits annuities, both of which are offered by insurance companies.
These products aim to provide you with a higher income than you would get from a traditional annuity, increasing over time, but returns are linked to the performance of shares, bonds and other assets, so your income is at the mercy of the markets.
How do they work?
With unit-linked annuities, your return is dependent on the performance of underlying funds, similar to the unit trusts you might hold in a pension or Stocks and Shares ISA. The risks of this approach depend on the funds you choose but if your investments don’t perform, or if markets are volatile, you could face a reduced or inconsistent income.
With-profits annuities, like other with-profits products, aim to reduce volatility, holding back some of your return in good years in order to top-up in bad years.
Should I consider them?
For most people approaching retirement, the attraction of an annuity is the certainty of a guaranteed income.
If you have a relatively small pension pot of under £100,000, and if your annuity will be your only source of income in retirement, apart from your state pension, investment-linked annuities are likely to be too risky.
If you have a larger pension, you could consider opting for an investment-linked annuity with some of your pot of money. However, watch out for high investment fees as these will eat into your returns. A good independent financial adviser (IFA) will be able to help you decide if a product is suitable.
Are there any alternatives?
Income drawdown is an alternative for those with larger pensions who like the idea of leaving pension money invested after retirement, while still receiving an income.
Investing in Stocks and Shares Isas can also be a way to supplement your pensions through an account that you can keep in place after retirement, taking income or selling investments as and when you need the money.
- Annuities – the comprehensive Which? guide to annuities
- Annuity alternatives – our guide to income drawdown and other options
- Which? Money Helpline – for a personalised solution, speak to our experts