Investment-linked annuities mean that you pension fund continues to be invested after your retirement. This means that you could continue to benefit from investment growth after retirement, but there is also the risk that the value of your investments and, therefore, retirement income could fall, as you would be exposed to falls in investment values. The underlying investments that the funds are invested in, whether in equities, bonds, gilts or property, will vary depending on the fund and its investment objectives.

If you are considering an investment annuity, please speak with one of Annuity Arrow experts for financial advice.

Investment-linked annuities can generally be either:

• with profits; or

• unit-linked.

With an investment-linked annuity you will be linking your income in retirement to the ups and downs of underlying investment instead of receiving a predetermined income, as you would with a conventional lifetime annuity.

With-profits annuities

Your pension fund is invested in an insurance company’s with-profits fund. Your income is linked directly to the performance of this fund.

Your income is usually made up of two parts:

• a starting income

This is normally set at a low level, with idea that unless investment conditions are very bad, you’ll usually get at least this much income. Some providers even guarantee a minimum level of income.

• bonuses

The insurance company usually announces bonus rates once a year. These bonuses can be both reversionary (usually paid each year for the duration of your annuity) and special (paid for a year or so) until the next bonus announcement.

The amount of any bonuses depends on many different factors, such as:

• investment performance;

• the financial strength of the fund; and

• the insurance company’s assessment of what it can afford to pay out in bonuses.

It must be emphasised that bonuses are not guaranteed.

Whether or not a bonus is declared or paid in respect of an insurer’s with profits fund is ultimately determined insurer. Many insurers have historically used a technique called smoothing to smooth the peaks and troughs of direct stock market investment. Smoothing means that in years of good investment growth companies hold back profits and use them to top up bonuses in years when economic conditions are harsher. This meant that wide changes to bonuses rates declared were avoided and insurers could still offer bonuses in years of poor performance because it had created a reserve. However, in recent years, many insurers have been forced to cut bonuses.

On a positive note, Prudential made its bonus declaration for 2008 which means that pensioners who have a Prudential with-profits annuity will receive a rise in payments of up to 11 per cent in 2008, compared to inflation of 3.1 per cent on a State pension at 3.9 per cent.

Unit-linked annuities

Your pension fund is invested in units in investment funds. Your income is linked directly to the performance of the funds you have invested in. This means your income level is likely to change and can go both up and down.

You can normally choose which funds you wish to invest in, which should match your attitude to risk. The more risky the underlying fund you choose, the more your retirement income may vary – both up and down.