Indexed Annuity
Annuities can be set up at their inception to provide an escalating level of income. They can be linked to a fixed percentage increase per annum, or to the Retail Price Index (RPI). Substantial differences in introductory income levels between escalating and non-escalating annuities are typical. However if an escalating annuity is chosen, the level of derived income will increase throughout the term of the annuity.
Illustrated Example
The illustrated example below is representative of a single life annuity, no guarantee period and a purchase price of £50,000
| Escalation | Initial Annuity Income |
|---|---|
| None (Level) | £3,188 p.a. |
| 3% | £2,211 p.a. |
| Retail Price Index (RPI) | £1,861 p.a. |
| 5% | £1,665 p.a. |
How does inflation affect buying power?
Inflation is, quite simply, the rate at which goods and services rise in price. This is typically measured by RPI, a percentage calculated from the rise in price for a typical basket of goods. Using the table below, figures have been laid out to show how long-term inflation can seriously devalue your buying power. The annuity figures are for a single life, non-escalating annuity. Key to remember is that income is not decreasing here, but buying power is.
| Inflation Value | Initial Income | 10 Years | 20 Years | 30 Years |
|---|---|---|---|---|
| 2.5% | £3,188 | £2,474 | £1,921 | £1,491 |
| 5.0% | £3,188 | £1,908 | £1,143 | £684 |
Of course if an indexed annuity is used, the buying power of the annuity would be maintained.
+ PROS
An escalating annuity can offset the effects of inflation.
If the annuity pays out for a long enough period it's total payments can be in excess of those of a non-escalating annuity.
- CONS
The income at the beginning of the annuity term is lower than the income of a non-escalating annuity and will take some time to match it, typically 13 to 15 years.
