If you’re nearing retirement, chances are you’ve started shopping for an annuity that guarantees a certain amount of income for the rest of your life. If you’re risk-adverse, you’ll likely opt for a level annuity or an escalating annuity.
Level annuities pay out a fixed amount over the lifetime of the annuity which means that over time the value of your payments will be eroded by inflation. Escalating annuities help protect you against the potential erosion from inflation by increasing the amount of the payment each year. The downside of an escalating annuity is that the initial income you’re paid is significantly less than what you’d receive from a level annuity.
Investment-linked Annuities – Upside Potential While Limiting Downside Risk
If you’re not thrilled with the potential amount of income payments from level annuities or escalating annuities, you might want to take a look at a newer financial vehicle known as an investment-linked annuity. Investment-linked annuities start with a specific amount of income which then rises or falls based on market conditions.
An investment-linked annuity ties the amount of your retirement income to stocks in which the annuity is invested. Since the income is tied to the performance of the stock market, you have the potential to significantly increase the amount of income you receive. What makes this type of annuity especially appealing is that some forms offer guaranteed minimum amount of income you’ll receive even if the stock market tanks. If you already have a secure source of income or are attracted to the potential for higher income, investment-linked annuities could be a reasonable annuity choice for you.
Types of Investment-linked Annuities
Investment-linked annuities come in two basic forms. The first is what’s known as a with-profits annuity. The second is the unit-linked annuity. Generally, a with-profits annuity will be much less risky than a unit-linked annuity.
How With-Profits Annuities Work
This type of annuity is linked to a with-profits fund. With this type of investment-linked annuity there is a minimum payout should the market conditions take a turn for the worse. The upside of having an annuity linked to a with-profits fund is the potential for a large payout in the form of a bonus should the stock market do very well.
How Unit-Linked Annuities Work
With this type of annuity, you have more control over the specific funds and asset classes in which your annuity is invested. Keep in mind that these types of annuities don’t offer a guaranteed minimum income. However, you can spread your risk by carefully selecting the underlying funds within a variety of asset classes. Nonetheless, since these types of annuities are inherently risky, you’ll want to make sure you are comfortable with the level of risk presented by these financial vehicles before committing to them.
Can You Live On the Guaranteed Minimum?
Investment-linked annuities have become very popular in recent years. However, before you jump aboard the investment-linked annuity bandwagon, make sure you have a firm grasp of your budget for your retirement years. Even if you choose a with-profits annuity, you need to be certain that if investments fall, you’ll be able to live on the minimum guaranteed amount from the with-profits annuity.
Consult With a Financial Advisor
Since income from investment-linked annuities are tied to projected market conditions, you’ll want to have a consult with a professional financial advisor. The advisor can help you ascertain your income requirements throughout your life, help you determine your risk tolerance, and give you a more thorough understanding of the potential risks and rewards of an investment-linked annuity. Your advisor will also help you understand any potential charges associated with an investment-linked annuity which might reduce the amount of income you receive.