A longevity plan could be the answer, but some experts says it's a gamble, writes Sally Hamilton

An investment plan offering retired people 'birthday units' to boost their income for each year they grow older sounds like an ideal gift for a pensioner. But the Longevity Income Plan (Lip), the newest arrival in the £14bn market for financial products that help to turn a lifetime's savings into a retirement income, is dividing the financial adviser community, with one labelling it a 'gambler's product'.

Supporters, including HSBC, which has just added Lip to its menu of retirement products for better-off customers, are keen on its central aim of providing the possibility of a rising income for pensioners in later years. This is a novelty for the elderly, whose fixed incomes tend to shrink each year due to inflation.

Critics point to the costs (5 per cent initial charge, 1.75 per cent average annual charge), complexity, restrictions and that income levels are not guaranteed.

Lip is designed for investors who fear running out of money should they live into their eighties or nineties. According to Andy Briscoe, chief executive of Life Trust, which devised Lip, a 50-year-old today has a one and four chance of living to 95 and a one in 10 chance of living to 100. 'Even inflation of just 3 per cent halves a typical investment in 23 years,' he says.

Lip investors are asked to take something of a leap of faith. They take out a lump sum investment of £5,000-£1m with the firm at least 10 years before their chosen maturity age of 75 or 80. The money is invested in one or more of 10 funds matching different risk profiles, and investors can move to safer funds as they near their maturity date. On maturity, an annual income will be paid out on their birthday for 20 years, the level of which depends on how the investment has performed and the rate at which fellow investors die. If the investor dies before the 20 years are up, the original investment is paid to the estate.

The novel aspect is the 'birthday units'. These are in effect 'death units' and are the payments that would otherwise have gone to investors who die during the year.

Bob Bullivant, chief executive of Annuity Direct, an annuity specialist, is wary of Lip, not only because of the investment risk but also the mortality risk.

'You're locking your money away very early,' he says. 'And you, or rather your estate, can only get at the money early if you die. And that aspect of the product is paid for by an annual insurance premium charged against the fund each year. It is the customer, not the provider, who is taking the mortality risk. That is the opposite of an annuity, where if you outlive your predicted lifespan, the annuity provider pays. With Lip, if investors live longer than anticipated they won't get any increase in their income.'

Bullivant reckons that investors with excess cash should look at more flexible plans to top up their pension saving, such as Isas, which have similar opportunities for investment growth and income can be taken tax-free. Boosting a pension before retirement is also more tax-efficient, with the government topping up contributions by 20 or 40 per cent.

Martin Bamford, of adviser Informed Choice, is also sceptical about Lip's central aim to increase income in later years. 'We find our typical customers spend less money later in retirement than earlier. I could see it playing a role in long-term care fees planning, though many people could tap into their homes for that,' he says.

Tom McPhail of adviser Hargreaves Lansdown, says: 'It's a clever trick focusing on the potential to increase your income in your nineties so long as your peers die off rapidly. But I think it's a gambler's product. I would suggest someone only looks at this after they have secured their retirement income and built up other portfolios.'

Briscoe comments: 'Any investment is a gamble and we believe this is no more a gamble than annuity rates. We are here to sit alongside annuities. I defend the charges robustly and think they compare well with other retirement products.'

Steve Conley, head of investment at HSBC, says Lip is not aimed at the mass market. 'This product has niche appeal. It is more appropriate for those with larger life savings who can use it as a small component of their planning to hedge the risk of longevity. It can help with long-term care planning, which otherwise can be unaffordable.' He says it is one of many products on HSBC's top-end advisers' lists, which also includes Aegon's Five for Life flexible annuity.

Aegon's plan is one of a new style of 'third-way' annuities, an idea imported from the US by firms such as Hartford, MetLife, Lincoln, Aegon and Living Time, with Axa and Standard Life soon to launch their versions. These are an alternative to level annuities, where investors put up with the same fixed income for life and usually lose the whole fund if they die soon after purchase; and income drawdown, where some income can be taken from the fund, leaving the remainder of the money invested until the deadline of 75 for converting into an annuity. With drawdown, funds can also be left to an investor's estate.

Third-way plans vary, but work along similar lines, investing in equities in the expectation of producing a higher income and guaranteeing that the original capital will not be eroded. Some let investors pass funds to their estate on death, while others guarantee there will be enough capital at the end of a fixed term (say five years) to buy a new annuity that will provide an income at least as much as the investor had before, possibly more, thus not tying them in to a fixed rate for life.

The attraction of having the chance to take out another annuity later is that rates paid tend to be higher the older you are when you buy the annuity. If your health has also deteriorated in that time, you can achieve even higher rates with impaired life annuities.

While third-way plans are likely to attract attention in the future, they are relatively expensive (though are expected to get cheaper as more plans are offered) and at the moment about nine out of 10 people still buy level-term annuities and just one in 10 a drawdown plan, according to McPhail.

There are ways to protect a level annuity income from erosion, either by choosing to increase the income at a fixed rate each year or in line with inflation. Investors can also buy guarantees for a number of years, typically five, that mean the fund would not be lost if they died within the chosen period.

Bamford says that the costs deter many from taking this action: 'One of my clients, a 71-year-old man with a pension fund of £192,500, has just chosen an annuity with a five-year guarantee that the income will be paid even if he dies in that time, and provide a two-thirds spouse's pension. This will pay him £14,988 a year [7.78 per cent]. I also quoted him an annuity that would increase at a fixed rate of 3 per cent a year as a hedge against inflation. But this would reduce his starting income to £11,244 [5.84 per cent] and take him nine years to get to the same level as the income received from the level annuity.'

Picking an inflation-proofed version would deplete early income even further. McPhail says most people take the level option for 'jam today' reasons.