LAST week I wrote about the importance of shopping around for your pension when you retire by taking the funds from your personal retirement annuity.
There is another choice, which is called A Living Annuity (LA). The LA is generally more appropriate for the investor who does not require income from the investment to support or to fund expenses.
The available funds are placed in a portfolio of the investor's choice. Investors, subject to certain restrictions, may elect to structure the fund as conservatively or aggressively as is appropriate.
The income derived is based on a percentage of the fund value each year, with a minimum of 2,5percent and a maximum of 17,5percent, which will be made available.
Upon an investor's death, dependents might elect to leave the annuity funds invested or have the remaining value paid out over a five-year period.
What is often overlooked is that an LA comes at a price. Poor investment decisions and drawing too much income could deplete the value of the funds and result in a fall of income in the last years of one's life.
An LA provides no guarantees that the pension will increase nor that the amount of capital will be greater on one's death.
The question I'm frequently asked is how appropriate is this type of annuity and what factors should one take into consideration before deciding on a Fixed or Living Annuity?
Everyone's circumstances are different. Choosing an LA is a bet against the life insurer that one can invest better than they can and therefore do not want to pay a premium for the privilege of not assuming the risks.
The following points below need to be understood prior to making a decision:
l In the case of a Fixed Annuity, the rate is fixed at inception. Fixed Annuity rates do fluctuate so, if rates are high at inception, this would prove advantageous. But if interest rates are low at inception, the investor would be locked into a low rate for life.
l The purchasing power of a Fixed Annuity will diminish over time as its value is eroded by inflation.
l The investors have more control in the case of a Living Annuity in so far as when selecting the desired level of annual income. However, they take on risk.
l A Living Annuity may be converted to a Fixed Annuity at the election of the pensioner.
But one may not switch from a Fixed Annuity to a Living Annuity. Thus, it may be in the investor's best interest to switch from a Living Annuity to a Fixed Annuity when interest rates are high.
l When weighing up the options of a Living Annuity, it is vital to obtain professional advice with regard to the structure of the underlying investments. This is to ensure these are appropriate for the individual's needs.
While an aggressive approach can achieve substantial capital growth during adverse conditions, this may result in negative or sometimes even disastrous implications.
l The writer is a director of Pioneer Financial Planning. Visit email@example.com