Unit-Linked Annuities

If you are getting close to retirement age you are probably thinking about purchasing an annuity to provide you with an income. An annuity is basically a plan taken out with an insurance company in exchange for your pension fund or any other lump sum, which will pay you an income for life. There are several types of annuity plans available to UK residents and this is a look specifically at unit-linked annuities.

What Is a Unit-Linked Annuity?

With a standard life annuity your pension fund is converted to a guaranteed income. A unit-linked annuity differs from the standard annuity as there are no guarantees about the income level. The amount of income paid will depend on how the underlying unit-linked fund performs. This type of plan is comparable to a with-profits annuity as the options are the same but the pension fund itself is invested in a unit-linked fund instead of a with-profits fund.

What Is a Unit-Linked Fund?

In a unit-linked fund, you buy units that are usually priced daily. The value of the units you hold will then move up or down in accordance with how the price moves. This is the same way that having shares in a company works, but a unit-linked fund will be made up of a number of different shares so you are able to hold a big portfolio of investments and spread your risk by investing in the fund.

How Do They Work?

Unit-linked annuities work in two ways. When you buy the annuity, you have the option to take out the plan based on a growth rate that is assumed. You are able to determine the amount that the fund needs to grow in order for you to receive the level of income required. If the fund performs better than expected your annuity income will increase, but if it underperforms your income will be reduced. Alternatively, you can purchase the annuity without an assumed growth rate. In this case, the income received will be directly dependent on the performance of fund that you are invested in.

Disadvantages and Risks

The main disadvantage of this annuity type is that the initial set-up charge is usually higher. This could well reduce the income amount that you would receive from the plan. By their very nature, unit-linked annuities carry significantly more risk than a standard pension annuity, so anyone who is risk-adverse and looking for a guaranteed income should certainly study the other options closely.

As pensions and the various options involved are complex, it is recommended to always seek professional advice before buying an annuity, as they cannot be changed once bought.