Inflation Proofed Annuities

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Inflation proofing or to use the jargon “escalation” means buying an annuity which will increase each year. You can opt for it to increase by a fixed percentage, such as 3% per year or the rate of inflation - very often referred to as RPI. There are some companies that will not quote for rpi linked annuities, but instead will quote LPI. This usually means that they will provide inflation proofed increases subject to a 5% annual maximum.

The main disadvantage with any sort of escalation is that it means that you start off with a lower level income. Typically if you opt for a RPI escalating annuity you will end up with a third less income than an annuity which does not increase - a level or fixed annuity.

If you assume that inflation was 3% p.a. it would take 13 years until an increasing annuity pays the same income each year as a level annuity, and 19 years until the escalating annuity has paid out more money in total.

For most people over the age of 60 taking out a level annuity, an annuity which does not increase is the best option. Since the “catch up” time is so long. However, if you have worries inflation is going to increase or are in your 50s, then it is worth considering an annuity which increases. 

As an alternative to inflation proofing it is worth considering an invested annuity, in particular a with-profits annuity. With this type of annuity you can take an initial level of income which would be the same as a level annuity. If the performance of the fund is better than assumed then the income will increase. Click here to find out more about investment linked annuities and with-profits annuities.

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