A way of avoiding this risk is to use a non-profit single-premium plan. Here, the company guarantees the rate of interest that will be earned on each contribution, the rate being that which it can earn at the date of each premium, as it is related to the current yield on long-term fixed-interest investments. The annuity rate is not guaranteed, however. It should be noted that the difference between this and the deposit administration scheme is that the non-profit plan guarantees that each premium will earn a specific rate of interest (different for each premium) in each year to retirement, whereas the deposit administration plan guarantees only that the rate earned will equal the chosen "link" rate, which will vary over the term. The non-profit single-premium method can profitably be used at a time when interest rates are high and an attractive rate can be secured.
Whatever the guarantee, however, it does involve the investment of premiums in some type of fixed-interest investment, and over long periods in the past this has usually proved less advantageous than investing in assets, such as shares and property, that are a hedge against inflation. The guaranteed type of scheme is therefore really suitable in only two cases: where the plan-holder has a very short time to retirement and wants a guaranteed return with no risk; and where the individual is using single premiums and "shopping around" each year for the best return.
Over a longer period the advantages ought to lie firmly with a with profit or unit-linked plan. The with-profit pension plan is similar to with-profit life insurance policies in that reversionary bonuses are declared at regular intervals. The main difference (apart from the tax differences already outlined) is that under the regular premium plan the company guarantees a minimum pension at retirement instead of a sum assured. This is done by working out the expected return over the period, and converting the resulting capital sum into an annuity. In the usual way, assumptions of the interest rate to be earned and the annuity rate at retirement tend to be conservative. Reversionary bonuses are then used to distribute the surplus, and terminal bonuses may reflect the investment experience over the period of the plan and the investment conditions prevailing at the date of maturity. Both these factors increase the amount of pension actually payable. A further factor is the annuity rate assumption; if this is lower than the actual annuity rate at retirement (as it usually is) then a vesting bonus may be declared to reflect this difference and this can add substantially to the actual pension (alternatively, the current annuity rate, instead of that guaranteed, may be used).
There are three basic types of plan available, namely guaranteed plans, with-profit plans and unit-linked contracts. The simplest are the guaranteed plans, which are of several varieties, the most straightforward of which is the deposit administration scheme. Here, each premium is guaranteed to earn interest at a variable rate linked to a key interest rate, the most commonly used being the building societies' mortgage lending rate. Each contribution will earn interest at this level for the period it is invested. Plans of this type may hold out the promise of very substantial benefits when interest rates... see: Types of Pension Plan