Guide to Investment-Linked Annuities

With all the hoopla surrounding the new pension freedom reform and the way it has changed in which a retiree can utilise their pension pot, the dilemma has only increased.

Should one utilise the new flexible income drawdown option or should one continue down the trodden road and buy an annuity?

The only reason why annuities are so popular is that people prefer the long-term stability that a fixed monthly income can provide them with.

To add to this, there is a guarantee that the income will be paid for the rest of the lifetime even if the annuitant lives to be a centenarian.

The catch is that annuity rates are not the best and there is a lot of shopping around to do. To add to this, inflation will keep eroding the value of your fixed monthly income.

In such a circumstance, one must consider investment-linked annuities which offer the best of both worlds.

What is an investment-linked annuity? 

An investment-linked annuity provides you with a guaranteed fixed monthly income (lower than a basic lifetime annuity). The upside is that this income can increase depending on the value of investments like stocks and shares, but will never decrease below the guaranteed amount. This will be paid until your death.

So, essentially, you will receive a fixed monthly amount which will either be more than the minimum guaranteed amount or equal to it for the rest of your lifetime.

There are two types of Investment-Linked Annuities:

  1. With-Profits Annuity: Your pension pot will be invested in the With-profits fund by the annuity provider. The with-profits fund is an investment pool that is usually invested in a broad range of options like shares, cash, bonds and property.
  2. Unit-Linked Annuity: While it is very similar to a with-profits annuity, a unit-linked annuity gives you more control over your investments. You can choose your investment assets, and your income will be dependent on the performance of these units.

Features you can choose

Similar to Lifetime Annuities, you can choose from varied features in an Investment Linked Annuity. These should be according to your current financial circumstance and your future cash-flow requirement.

  • Opt for a Joint-life annuity if you have a dependent spouse or partner (Also called Widow’s Pension)
  • Choose a guarantee period (five or ten) years which may increase the minimum guaranteed payment
  • Select Value Protection wherein any person nominated by you will receive the unused value of your pension pot in the event of your death
  • Opt for enhanced annuity if you are in poor health or have a shorter life expectancy

To get the best rates and features, it is recommended that you shop around for your annuity.

Pros and cons

Retiree’s usually shy away from investment-linked annuities due to the perceived fear of risk. A unit-linked annuity, for example, invests mainly in equities which are usually considered a risky proposition, especially if you are nearing retirement.

On the other hand, a lifetime annuity offers a sense of safety by providing a fixed lifetime income without revealing the fact that the value of this income will reduce with time.

What are the pros and cons of an investment-linked annuity?

Should you opt for it?

Pros

  • The With-Profits annuity depends on the provider’s fund value. If this increases, your monthly income can increase significantly.
  • You can customise the initial income to suit your current circumstances by anticipating the rate of return on the investments.
  • If you are planning to continue working or have other income sources, you can opt for a lower monthly income initially which can potentially increase your income in the later stages of retirement depending on how your investments perform.

Cons 

  • The value of your annuity provider’s funds may fall at any time. This will reflect directly on your monthly income.
  • Specialized Investment-linked annuities have higher charges as compared to basic lifetime annuities. The higher fees can reduce your monthly income during retirement.

Irrespective of what type of annuity you decide to buy, Finance.co.uk recommends that you seek independent professional advice.

You can also use the free guidance provided by the government-backed Pension Wise service.

Where to Find the Best Paying Charity Accounts

If you are looking at charity savings accounts, you may not be too excited by the interest rates that they currently offer.

As a result, the hard-won funds of your charity may only be earning an inadequate amount of money… but it does not have to be that way!

While well-known banks and building societies do not tend to give the best rates on the market, there are other providers that you can choose from. As a trustee, you will need to be prepared to shop around to discover the best charity savings rates.

If you take the time to look, there are a number of higher-paying accounts that are available to charities, with the majority being granted by providers that are smaller and lesser-known.

The best rates on charity deposit accounts will be given when your organisation:

  • Can commit to not having near-term or immediate access to its funds. Fixed rate and notice accounts offer higher rates than accounts allowing easy access.
  • Consider Business Deposit Accounts as an alternative
  • Has a sizeable amount of money to save. For example, charities with £50K to invest will presumably secure better interest rates than those with more modest amounts to invest.

See:  The Basics of Business Deposit Accounts

How Do Faster Payments Work?

Faster payments do exactly what they say on the cover: they are a way to perform payments faster. But how truly fast are they? And how do you make one from your bank account?

Making use of faster payments can determine the difference between paying or missing that red bill, or getting your cash-strapped child at university the required money to pay their rent before they dive into their overdraft yet again. Faster payments mean that the excruciating waiting period that is added to payment transfers is lessened– giving you and those you are paying extra peace of mind.

How do faster payments work?

The Faster Payments Service enables customers of certain banks or building societies to perform quicker electronic payments or transfers online or over the phone.

Funds can be accessed and transferred within a couple of hours instead of days while standing orders, on the other hand, can be set up in one day.

Banks and building societies that are operating the Faster Payments Service are able to perform processing of payments and transfers 24 hours a day, any day of the week which includes weekends and Bank Holidays.

Four things to check when making a faster payment

There are four things that you need to check before you can make a faster payment:

  1. Does the provider of your current account take part in the Faster Payments Service? Not all banks and building societies are participating in the said service. You can find out here if your current provider is a participant in the said scheme.
  2. Verify if there are any transaction or daily value limits on the amount of money that you can transfer using the Faster Payments Service. Your payment may be rejected if the amount exceeds the value limit your provider.
  3. If you are paying a bill, verify if the company that you are paying is accepting faster payments (you should be able to look for this information on the back of a utility bill for instance, or by contacting them).
  4. If you are making a payment to an individual, check if their bank or building society are accepting faster payments.

A Guide on Savings Accounts

Savings accounts come in various forms. However, they all aim to build up a lump sum of money that you can use for whatever purpose that you like.

You may be saving for to build up an emergency fund or for a specific purpose, or just for a rainy day.

Savings accounts normally come in the form of deposit accounts, which lets you earn interest on the money that is held in the account. Providers will then use that money to lend to other customers in the form of mortgages, loans, and credit cards.

Most people perceive savings as regularly putting a little money away to build up a large pot of money. However, there are some savings accounts that allow lump sum amounts and intend to increase the value of them.

Different types of savings plans

There are a lot of shapes and sizes of savings plans such as:

  • Cash ISAs allow you to grow your savings tax-free.
  • Internet savings accounts are specifically run over the internet. Interest may be slightly higher since the accounts are cheaper to run.
  • Instant access savings accounts allow you to have immediate access to your money without any penalty.
  • Notice savings accounts require you to issue a notice of withdrawal. You will be penalised by a loss of interest if you cannot provide the notice period that you need to, and in some cases, you would not be permitted to have access your money early at all.
  • Children’s savings accounts or specialist over-50’s savings accounts may have several features that you (or your kids) will be able to benefit from.
  • Savings plans can be on a fixed interest rate or variable interest basis.
  • Offshore savings accounts allow you to receive interest gross or even defer it to manage your tax liabilities.

How savings providers make their money

National Savings Accounts that backed by the UK Government include a number of tax-friendly accounts for children and adult.

There are no charges to set up a deposit savings accounts and normally no fees either. Providers make their money by making use of your savings to lend to other customers at a rate that is higher.

You may be penalised for early withdrawals on a notice account, which saves the provider from paying a certain amount of interest, thereby increasing their return.

Taxation

From April 6, 2016, people who earn under £150,000 will receive a Personal Savings Allowance, which means that the first portion of interest that is earned in a tax year is tax-free. If you are a basic rate taxpayer, this amount is £1,000, and if you are a higher rate taxpayer, it is £500 (taxpayers with highest rates do not receive an allowance).

However, you must be careful as this does not just apply to normal savings accounts. If you earn interest on investments, such as Government gilts or corporate bonds, or if you receive an income from any fixed interest investment funds that are classified as ‘interest dividends,’ then they will also be included in your £1,000.

This allowance does not apply to some National Savings & Investments products and cash ISAs, as these are already tax-free anyway.

If you earn some money over your allowance amount, you will be required to declare your interest to the HMRC and pay any tax that is due.

Read also: Can You Still Receive a Decent Return on Your Savings?

What is a Net Rate?

What does a net rate mean?

Net rate is the rate of interest that you receive on a savings account after tax (specifically after the basic rate tax of 20%, or the VAT) has already been deducted.

You may notice a net rate of interest shown by some banks and building societies on websites or literature. However, as interest is now paid without the deduction of tax, net rates may not be so well broadcasted (however, they are still important if you earn more interest than what your Personal Savings Allowance allows).

As with the gross rate, the net rate shows you what you would receive at the beginning of taking out the savings account. Compound interest (where you receive interest on your original investment and any accumulated interest thereafter) is not taken into account, and nor does it give an annual rate like an AER does, if the savings account that you are looking at has an introductory bonus of less than a year.

A net rate usually only reveals the rate of interest that you would receive at the outset if you are a basic rate taxpayer, so if you pay a higher rate or an additional rate tax, it can be a misleading comparison. Remember that if you are a basic rate taxpayer, the personal savings allowance means that you can earn £1,000 in savings interest per tax year before tax is deducted (if you are a higher rate taxpayer the amount is £500, and if you are an additional rate taxpayer, you do not get a savings allowance at all).

In order to determine what your personal net rate of interest is, you would need to deduct your tax rate (higher rate at 40%, additional rate%, 45%, the basic rate at 20%) from the gross rate.

For example, if the gross rate that is offered by a savings account is 3.00% and you are a taxpayer with a higher rate, you would do the following calculation:

3 – 40% = 1.80%

Making use of your own “net rate” is also an excellent way to compare the gross rate on a cash ISA against a non-ISA savings account.

The Basics of Peer to Peer Savings

Peer to peer savings is also known as P2P. Peer to peer lending or crowdfunding is a way to look for high rates of interest as a return for lending your savings to others. Here is a guide on what you need to know before you invest in peer to peer savings.

What is peer to peer savings?

Peer to peer savings is a loan based platform which converts your savings into a lending stream for possible borrowers.

This means that you can lend your money to others for a fixed return, in the similar way that a bank or building society offers loans.

This is how a peer to peer savings works:

  1. Add your savings to your selected P2P providers’ platform
  2. Lend your money to a borrower via the P2P provider
  3. The borrower repays your money back with interest over a fixed term – earning you a profit

You can decide on how long to lend your money for, with terms that are as long as 6 years or as short as 31 days.

However, be careful on how long you tie your money up for, as there are penalties that may be charged for withdrawing your funds early.

How much can you save?

There is no maximum amount to how much you can save so you can save as much as you like.

However, there is a minimum limit on the amount that you have to lend; usually around £10 or £25.

As P2P savings acts like a loan, there is a risk that you may not get your money back if the borrower cannot keep up with their repayments which is known as defaulting.

For this reason, you should always spread the risk by lending your savings to various borrowers.

Higher investments, such as £50,000, can become longer to distribute to borrowers which implies that you will need to wait longer in order to receive a return on all of your money.

Who can you lend your money to?

This depends on the provider that you select. The typical types of borrowers include:

  • An individual: this is somebody that is looking to borrow money, who may not have been able to receive credit through traditional methods, for example, through a bank
  • A start-up business: Every new enterprise which requires funds for development or  expansion in their business

Depending on the need for funds, you may have to wait for a few days or  a few weeks until you can lend your money out.

P2P providers will store your money in a holding bank until you can lend it out, with some providers offering a small amount of interest during this time.

Can anyone borrow your money?

No. Borrowers must pass a range of checks to qualify for P2P lending.

These checks are completed by the P2P provider, and these include:

  • A full credit check
  • An identity check
  • An affordability assessment

If the P2P provider you selected is registered with CIFAS, they will also execute an anti-fraud background check on each borrower. They will not perform this check if the provider is not registered with CIFAS.

Which borrower should you decide to lend to?

Individuals are characterised based on their credit history which also has an effect on the amount of interest that you can get in return for your money, broadly speaking:

Borrowers credit historyRisk to your moneyYour interest rate
ExcellentLowLow
PoorHighHigh

Start-up businesses are not classified by their credit profiles so you will have to research the company before you decide to lend to them.

Does it cost you anything?

Yes, most providers will require an annual servicing fee of about 1 percent. This is deducted from each repayment before it gets to you.

If you decide to withdraw your savings during a fixed term, you will be charged with a sale fee; this is normally around 0.25 percent. The sale fee includes the costs of looking for a new investor to put in the amount that you take out of the fixed term loan.

If you decide to withdraw your money at the end of an agreed term, you will not be charged.

Do you pay tax on P2P savings?

You pay for tax on P2P savings. However, your provider will not automatically subtract any tax from your interest, unlike building societies or banks.

You will have to declare any P2P savings interest that you earn by accomplishing a self-assessment form at the the tax year’s end.

Can you make use of your ISA allowance with P2P savings?

Yes, if you have an innovative finance ISA, you can save into a peer to peer investment with the use of your tax-free ISA allowance.

This means that the interest that you earn will be tax-free and that you will not be required to accomplish a self-assessment form for any ISA money you have used in P2P savings.

When will you get your interest?

You will get your interest usually at the end of the lending term that you have chosen. However, this depends on whether you lent your money on a rolling term basis or a fixed term:

  • Rolling term: A portion of your capital and interest, every month for a set term will be paid to you. This means that you can re-invest or withdraw your monthly capital repayments after each month if you want to.
  • Fixed term: You can lend your savings for a fixed period, for example, one year, and you get your capital back at the end. You can also decide to have any interest given to you on a monthly basis.

Where to invest in peer to peer savings?

It is only an online savings platform, and every provider has its own methods of operating.

You should analyse all of the P2P savings and investment providers to look for the one which will offer you the best return on your savings.

To start saving, you must register on the website of your chosen provider, add your savings, then from a list of borrowers, select who to lend your money to.

Will your peer to peer savings be protected?

There is usually no protection under the FSCS, which means that you would possibly lose your money if you save via a provider who fails.

Some P2P providers have their own schemes which will cover your savings if a borrower default on their payments.

These schemes include a definite amount of money to cover any default payments. If a huge amount of borrowers default at the same time, the scheme may not have adequate money to cover the entire loss to each investor, meaning that you could lose your money.

Make sure that you check the details of any scheme proposed by a provider before investing your money.

Is peer to peer savings regulated?

Yes. Since April 2014, peer to peer providers are regulated by the FCA, which means that every provider has to comply with the terms that are listed below:

  • Your money must be protected by providers that are meeting certain capital requirements
  • Be clear and transparent regarding the risk and who are to borrow your funds
  •  If their platform collapses, providers must have plans in place in order to collect your money

You can check if a peer to peer company is regulated by looking for their name on the FCA register. However, being regulated does not mean that they are covered by the FSCS.

Can you Afford a Mortgage?

Before buying a home, examine whether you can afford the cost of a mortgage. Here is a guide on how to check if lenders will accept your application and if you can be able to keep up with the repayments.

Check if you can afford a mortgage

To work out the amount you can afford to spend for a home, you need to consider:

  • Your outgoings
  • Your total income

Deduct your outgoings from your income to determine how much you can pay for a mortgage every month. You can then dodge getting one with repayments that you cannot afford.

You can determine how much you can spend on a home with the use of a mortgage cost calculator. Just type in the mortgage amount, interest rate, and the mortgage term to check how much repayments will cost.

Verify if you can afford the mortgage by comparing the calculated amount to how much you can afford to pay every month.

 

Will lenders accept your mortgage application?

Lenders have to carefully review your financial circumstances before they can grant you a mortgage. The rules of the Financial Conduct Authority’s (FCA)  means they have to ensure that you can keep up with the repayments.

To determine how much you can afford to repay, they will have to look at:

  • If you are in permanent full-time employment
  • How much you earn
  • Your outgoings and the things that you spend your money on
  • If you have people that financially dependent on you, i.e. children
  • Your outstanding debts

Lenders will also base their judgment on:

  • Your credit history: This informs lenders how much your outstanding loans are and how well you have handled debt in the past.
  • Your age: If you are close to the retirement age, you may only be offered shorter-term mortgages, and you normally need a larger deposit. (See: How to Obtain a Mortgage if You Are an Older Borrower)
  • Your deposits: The more you can place down as a deposit, the lower the risk for the lender. Putting down a large deposit will give you more chances of being accepted, and you should also be able to be offered with a lower interest rate.
  • The value of the property: The size of the mortgage you need will have an effect on whether lenders think you can afford to keep up with the repayments.
  • The mortgage term: A shorter mortgage term implies higher monthly payments, so you may only be admitted for a larger mortgage if you pay it off over a longer period.
  • If you apply on your own or jointly: If you apply for a joint mortgage you may be able to borrow more since the income of the other person will be taken into consideration as well.

They also administer stress tests to examine whether you could still afford your mortgage if interest rates increased or if your circumstances changed, i.e. if you lost your job.

Work out your income

Sum up the following to determine your monthly income:

  • Your salary, including overtime and regular bonuses
  • Any income from your pension
  • Benefits and tax credits
  • Income from your investments, including shares, property and savings
  • Money you receive for child maintenance

Work out your outgoings

Make use of a calculator like Nationwide’s budget planner, to sum up the amount of money that you spend every month.

Alternatively, determine your essential living costs and other expenditures yourself:

Calculate your living costs

Credit card balancesOutstanding loans or overdrafts
Food and drinkInsurance you pay for
Student loan paymentsPension payments
Council taxToiletries and cleaning products
Mortgage payments or rentTV licence and subscriptions
Electricity, gas and waterInternet and phone
Petrol and car maintenanceTravel fares
Clothes and accessoriesMoney you save
ChildcareChild maintenance payments
School fees or costsPet costs

What else do you spend on?

Determine the total of how much you spend in an average month on:

  • Holidays and travel
  • Entertainment like music, the cinema, or sporting events
  • Your social life, including seeing friends and dining at  restaurants
  • Buying alcohol and cigarettes
  • Gym memberships and other exercise costs
  • Gifts for other people or luxury purchases

How to afford a mortgage

If your income is presently too low to secure a mortgage on the property you want, you could wait until your income becomes higher or consider the following:

  • Choose a cheaper property, as a lower purchase price means lower mortgage payments.
  • Choose a longer mortgage term, which decreases the amount that you repay every month. However, you will have to pay a higher amount overall.
  • Look for a cheaper mortgage since a lower interest rate can make the repayments more affordable.
  • Lessen your expenses and unnecessary costs. Consider making a budget and spend less.
  • Increase your deposit, which should help you receive a cheaper mortgage.

You should also take into consideration income protection insurance, which could satisfy your mortgage repayments if you were unfit to work due to an illness or accident.

Get the right mortgage

Avoid applying for too many mortgages if you get rejected since this can hurt your credit record and make it more difficult for you to get accepted.

Deciding on the right mortgage for your circumstances can help you get accepted and come with lower costs than unsuitable deals.

You can get mortgages designed for:

  • Buying your first home
  • Self-employed borrowers
  • Older borrowers
  • If you have a small deposit
  • If you have bad credit

Save on bills

You can also cut down on other expenses like the following:

  • Electricity bills
  • Council tax
  • Water bills
  • Gas bills

What Is a Unit Trust?

A unit trust places your money in the hands of an expert fund manager together with other investors. Here is a guide on what you need to know about unit trusts before you invest.

What is a unit trust?

It is an open-ended grouped investment product, meaning that there is no restriction to how many people can invest in it or the amount of money that can be invested. You purchase units with the investment you make in a unit trust.

How does a unit trust work?

It works by placing your money with other investors into a single fund, which is controlled by a fund manager.

The fund manager then makes use of the unit trust fund to invest in asset classes through various securities.

However, not all securities have the same risk levels, so make sure that you are happy with the risk involved with your selected unit trust.

Where do unit trusts invest?

The fund manager will make use of the unit trust fund to invest in various securities within a specific or selection of classes of assets.

Each investment can be categorised further into an investment region, industry types, and asset classes. Some of the different types include:

  • Investment region: for example, global emerging markets, UK, US, and Japan
  • Asset class: for example, equity, allocation, fixed Income and property
  • Industry sector: for example, real estate, energy, utilities and healthcare

By investing in a range of different investment regions, asset classes, and industry sectors, fund managers can expand where your money is held to try and reduce risk.

How does a unit trust make you money?

You earn money by selling your units at a higher price than you originally purchased them for.

What is a unit?

When you invest in a unit trust, you are purchasing units in the trust with other investors. Every unit has an individual price which is called the Net Asset Value (NAV). More units are created to meet your demands, so there is no restriction to how many units are produced in a single unit trust.

The NAV reflects the value of the overall assets of the unit trust, for example, the investments the fund manager has made with the fund.

This is how the NAV is calculated:

  • Unit trust assets are worth £100,000
  • There are 50,000 units already in issue
  • To find out the NAV, you divide the value of the assets by the number of units already in use, so 100,000/50,000 = 2
  • This means that the NAV is £2

The NAV does not represent the price that you will pay for a unit in a unit trust. The price of a unit is affected by administration costs including the initial charge.

When should you sell your units?

The amount at which you buy or sell units will be calculated using a bid-offer spread.

The way a bid-offer spread is calculated varies between fund managers. It represents the difference between how much you sell and buy a unit for.

For example: Offer price (buy) = £2.10 – NAV = £2 – Bid price (sell) = £1.90

If you purchase a unit at the offer price of £2.10, you must wait until the bid price is higher; otherwise, you risk to lose money.

For this reason alone, a unit trust is not a short-term investment; it can take time for the unit’s ‘sell price’ to outperform the original price that you bought them for.

How else can you get a return on your investment?

This will depend on the unit type you invest in and whether your unit trust is making money or not, such as:

  • Income units: Investing in income units means that you receive a pay-out up to several times per year*.
  • Accumulation units: Investing in accumulation units means that any income will be reinvested in addition to your existing units*.

See also: Should You Invest in a Unit Trust?

You may be liable for Capital Gains Tax if you decide to sell your units – you may visit the GOV.UK website for more information.

What are the fees for investing in a unit trust?

There are some charges to look out for when investing in unit trusts, these include:

  • Annual management charge (AMC): This can be between 0.5 – 2%. It pays for the management of the unit trust.
  • Brokerage fees: This varies from broker to broker.
  • Initial charge: This charge can be around 3-5% of your deposit and only applies if you decide to invest without seeking advice. However, this can be avoided by investing through a broker. Initial charges are sometimes replaced with exit fees instead.

How can you invest in a unit trust?

  • Broker: Talk to a broker regarding your unit trust needs to look for a unit trust that matches the level of risk you are prepared to take.
  • Direct from fund management company: You can directly apply with a fund management company, like Hargreaves Lansdown, who will take you through the process of application.
  • Independent financial advisor (IFA): Seek independent advice from an IFA for an unbiased discussion on the kind of unit trust you should invest in.

Investing in a unit trust via a broker can save you money on fees compared to investing directly.