To key to understanding how with profit annuities work it is important
to appreciate the difference between an "anticipated bonus" and
the "declared bonus".
Anticipated Bonus (ABR)
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Declared Bonuses
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The ABR determines the starting income and is used when calculating
how much the income goes up or down at the anniversary of the policy
The higher the ABR, the higher the starting income. An ABR 0f 4%
will currently (March 2004) provide a starting income similar to a
level annuity.
However a high ABR reduces the scope for future income growth as
it is deducted from the annuity each year before applying the new
bonuses
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Declared bonuses are the actual bonuses awarded to with profit policies
each year.
There are two types of bonuses. Regular or reversionary bonuses and
Top up bonuses or terminal bonuses.
A regular bonus is added to the pension each year and the new pension
amount is carried forward each year. If a top up bonus is declared,
it is applied in that year only.
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An example
The best way to explain profit annuities is to work through an example.
A man aged 60 with a wife aged 57 investing £ 100 000 for a 2/3 rds joint
life annuity with anticipated bonus of 3%, would get a starting income
of £ 5,225. If at the end of the first year a regular bonus of 4% and a
top up bonus of 1% was awarded, the income in year 2 would be:
What anticipated bonus rate (ABR) should you choose?
The level of anticipated bonus depends on your individual circumstances and income requirements.
- 5% ABR is the maximum bonus allowed at present (March 2004) but some companies have a max of 4%
- Although a high AB provides the highest level of starting income, it reduces the potential for future growth and increases the risk of the falling in future years
- Although a lower ABR reduces the starting income it reduces the risk of income falling and increase the potential for income growth in the future
Comparing the income from with profits annuities
The following table chart compares the starting income from with profit annuities with different anticipated bonuses
£100,000 purchase, joint life annuity, man 60, female 57, 2/3rds widows