Annuities Example 25

Mr and Mrs Bird (both aged 70) wish to take out a joint life and survivor annuity. For an investment of £500,000 they will receive £111,400 a year until the survivor dies. The return under this type of annuity can be improved by stipulating that after the first death the income is reduced by some proportion, usually one-third. If Mr and Mrs Bird were to agree to this, then their £500,000 would purchase the payment of £111,570 a year until the first death and £111,047 thereafter until the second death.

Such annuities are, of course, even more vulnerable to inflation and the survivor may be left with a quite inadequate income. So care is necessary in making such an arrangment.

The problem of inflation can be partly surmounted, but only at the expense of the original income. Some offices offer increasing annuities, where the annual payment increases by a fixed percentage or amount each year. Provided the annuitant is prepared to sacrifice part of the original income and expects a long life, this may be a worthwhile alternative to the ordinary annuity method.

Example 26

Mr Carr is aged 70; his family were all long-lived and he expects to live to a ripe old age himself. He decides on an increasing annuity and is quoted a starting payment of £111,550 increasing by 3% p.a. for an original investment of £500,000 (the level annnuity at his age would be £111,800). If he survives for 10 years, the annual payment will be £12,015.

Because a considerable period has to elapse before escalating annuity instalments will match those which would have been available under a level annuity, it is often preferable to buy the smallest acceptable level annuity and to retain capital which can be used to buy further policies later, when the purchaser is older and can obtain a better rate. But again, the effects of inflation on the retained capital should be considered.

One recent development of a scheme involving the use of immediate annuities deserves mention, though it is rather complicated. Old people often have few assets left other than the house in which they live (usually one they have bought for retirement). These are the people who may need to raise their incomes to make up for the effects of inflation. One way they can do this is by raising a loan on their home from a life insurance company and investing the money in an immediate annuity (in the case of a couple it will be on a joint life and survivor basis). Loans of up to 80% of the value of the house (with an upper limit of about £120,000) can be obtained. The interest payments on the loan are met out of the annuity payments. This leaves a small amount over, which is paid out to the annuitants. But they can also reclaim tax relief on the loan interest from the

Inland Revenue (provided, that is, that they have sufficient income tax liability). Usually the interest rate on the loan is fixed for the life of the plan at some low rate such as 7% p. a. ; the annuity rate is usually also below the normal market level to compensate for this. The return from the scheme will depend on the age of the annuitants.

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Annuities Example 23

Mr Vite, aged 70, wants to take out an immediate annuity and finds that rates quoted vary from £11170 per £111,000 to £11185 per £111,000 of purchase money. His cousin Mrs Wade, however, who is the same age, finds that the best she is offered is £11165 per £111,000.

Many annuitants' main fear is that they will die soon after purchasing an annuity and get little benefit from it while their capital will be lost to their heirs. The most common answer to this is the guaranteed immediate annuity, which is payable for a fixed number of years and thereafter... see: Annuities Example 23

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