How much is an inflation linked annuity extra and is it good value

• How long can it take for income to catch up with a “level” annuity?
• What are the risks of inflation with a 20-year pension?
• Money experts read the numbers and explain what to consider before buying

Annuity deals have soared in value over the last few years, but the best rates are for single life, no annuities at ‘level’ of inflation.

On £100,000, a healthy 65-year-old can secure an income of well over £7,270 a year, according to Best Buy figures – see below.

If you want an annuity that increases by 3 per cent a year, or in line with the rate of retail price index inflation, you could save £2,000 a year or more.

So the level of an annuity might look attractive with inflation now back at 2 percent, but recent history has shown the dangers of locking in income for life without protection against sudden increases in the cost of living.

The headline inflation rate exceeded 11 percent in October 2022, a 41-year high.

If you’re looking for an annuity, how do you know if an inflation-protected annuity or no annuity is a better option for you? Money experts read the numbers and offer tips on how to choose below.

Annuity Inflation Protection: How Much Extra Does It Cost?

A 65-year-old on a £100,000 pension can get up to £7,220 a year right now from a single lifetime annuity with a five-year guarantee, says Helen Morrissey, head of retirement analysis at Hargreaves Lansdown.

The warranty period protects against losing all or most of your purchase money if you die shortly afterwards.

The top rate is more than £2,000 a year more than you would have three years ago, notes Morrissey.

But he warns: “The amount of income you get from such an annuity doesn’t change over time, and what may seem like a healthy income today may seem decidedly flat 20 years from now.

“An RPI-linked annuity currently delivers up to £4,540 a year to a 65-year-old on a £100,000 pension.

‘The one that increases by 3 per cent a year will start you on up to £5,157.’ Both of these rates will also include a five-year warranty.

Morrissey says the latter two deals can be much lower than you’d get with a level annuity, but the longer you live, the more you’ll appreciate any sort of inflation-linked bond. This is shown in the table below.

“When deciding what your best option is, you’ll need to try to figure out how long it will take for your escalating annuity income to catch up with your initial level one income,” says Morrissey.

“If you went for an RPI-linked product and it grew at 5 per cent a year, it would take you 10 years to make up lost ground and around 20 years to catch up to the same total income. how would you get from the level product.

“Obviously if RPI inflation was higher you would break even faster, but lower inflation means it could take you longer.”

He says that with an annuity escalating at 3 percent a year, it would take 12 years to catch up, so you’d be 77 before you’d get the same income.

And it would take about 21 years to get the same total income of around £144,000 as you would from the tiers product.

Morrissey says: ‘You need to carefully consider how long you are likely to live to make the best decision for you.’

Unless you have an existing medical condition or family medical history that you think might affect you, the answer to that is unknown.

But at least crunching the numbers will give you a better idea of ​​the risks you’re taking when buying an annuity with or without inflation protection.

Morrissey warns: “The inflationary beast may have been tamed, but that doesn’t mean it shouldn’t be a key factor in planning your retirement income.

“You could be retired for 20 years or more, and even the most favorable inflationary environments can eat away at your purchasing power during that time.

“A period of double-digit inflation, as we’ve seen recently, can take huge chunks out of your plans, so it pays to be prepared.”

He says you can consider other options, such as not paying out the entire pension at once.

“Instead, you could pay out pensions in installments over time, providing as much guaranteed income as you need, leaving the rest invested where it can hopefully grow.

“This way, you also have the benefit of securing higher annuity rates as you age, and if you develop a condition where you qualify for an increased annuity, you can get an additional income boost that can help combat the impact of inflation over time. ‘

Why are annuities a better value again?

Many people give annuities a different perspective. Sales last year hit their highest level since pension freedom reforms in 2015 saw most pensioners start living off their investments in old age.

Annuities provide guaranteed income until death.

But they’ve been shunned for years because of poor rates and restrictive terms, and after gaining a bad reputation over annuity mis-selling scandals.

Pension freedom reforms have prompted most savers to keep their funds invested and live off withdrawals instead, despite the associated financial market risk.

However, recent inflation-fighting interest rate hikes mean that annuity providers can afford to fund much more attractive deals, leading to a resurgence in sales.

The next move in interest rates is likely to be lower, meaning that annuity deals would again decline in value.

That doesn’t mean you should rush into deciding how best to fund your retirement. Scroll down to find our tips on what to consider before buying an annuity and check out the following guides.

> Read the 12-step guide to investing your retirement

> Find out how to combine investment withdrawals with an annuity

Fixed Rate Versus Inflation-Linked Annuities: How to Decide

Nick Flynn, director of retirement income at Canada Life, offers the following tips.

1. Consider how your annuity income may change in the future

Inflation-linked annuities will usually have a lower initial income than a fixed-rate annuity, but this can change over time.

Some simple assumptions about the future direction of inflation will allow you to model how your inflation-linked annuity may increase in the future, at what age your income may catch up with your fixed annuity, and at what age you are likely to receive more income than you originally paid for it.

2. Check how the provider applies inflation to the annuity rate

If you’re considering an inflation-linked annuity, it’s important to understand how the provider defines and measures inflation and how it will apply changes to your income.

3. Consider your tax position

Make sure you consider your overall tax situation and assess all the tax implications of your annuity along with any other income you may receive.

An inflation-linked annuity that increases over time may suit some people’s current tax situation, while others may prefer the higher initial income that comes with a fixed-rate annuity.

4. Consider a mixed approach

Unless you have a very small pension fund, you will usually have more than one option.

It may be that a blended approach – such as a combination of fixed annuities and inflation-linked annuities or introducing a drawdown element – ​​gives you the best chance of meeting your retirement goals.

5. Do your research and speak to a regulated financial advisor

Shop around and get quotes from more than one provider and do your initial research to better understand your options.

Then speak to a regulated financial advisor who will be able to help you reach a decision that best suits your situation and needs.

What you should keep in mind when buying an annuity

• You can get a “boosted” rate if you wait to buy an annuity until you are older and your health has deteriorated.

• You can rethink your investment and withdrawal strategy and buy an annuity in tandem or as a replacement source of income later, but once it’s bought, you can’t get out of the annuity.

• If you’re healthy, the best rates are for single life, no annuities at ‘level’ of inflation, but recent cost-of-living pressures highlight the importance of getting some protection against rising prices.

• If you buy a single, rather than a joint, life annuity, there will be nothing for your spouse if you die first, so consider what they will have to live on and discuss this with them before you decide. Many widows and widowers find that their partner’s annuity choice has left them with no income after their bereavement, forcing them to live on meager government benefits.

• Consider buying an annuity with a “guarantee period” that protects against losing all or most of your purchase money if you die shortly thereafter.