How much extra is the annual cost associated with inflation?

• How long can it take for income to be earned with a ‘level’ annuity?
• What are the risks of inflation in a 20-year retirement?
• Money experts crunch the numbers and explain what to consider before buying

Annuity deals have increased in value over the past few years but the best rates are on single life, not inflation-linked ‘level’ annuities.

For £100,000 a healthy 65-year-old could lock in an income of more than £7,270 a year, according to Best Buy information – see below.

You can put down £2,000 a year or even more if you want an annuity that rises by 3 per cent a year or the retail price index in line with inflation.

So, the annuity rate looks attractive with inflation now coming in at 2 percent, but recent history has shown the dangers of locking up income for life without protection against sudden increases in the cost of living.

Headline inflation rose to 11 percent in October 2022, a 41-year high.

If you’re in the market for an annuity, how do you work out whether one with inflation proof or none is the best choice for you? Money experts crunch the numbers and offer tips on how to make the following choices.

Annual Inflation Proofing: How Much Extra Does It Cost?

Helen Morrissey, head of pensions analysis at Hargreaves Lansdowne, says a 65-year-old with a £100,000 pension can now get up to £7,220 a year from a life annuity with a five-year guarantee.

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

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

But he cautions: “The level of income you get from this type of annuity doesn’t change over time, and what looks like a healthy income today may feel like a significant decrease in 20 years’ time.” do

RPI-linked annuities currently offer £4,540 per year for 65-year-olds with their £100,000 pension.

‘Those who rise by 3 per cent a year will start you up to £5,157.’ Both of these prices will also include a five-year warranty.

Morrissey says the latter two deals may be much lower than you’d get with a level annuity, but the longer you live, the more you’ll appreciate any inflationary link. This is shown in the table below.

“When deciding what your best option is, you need to try and work out how long it will take for your incremental annual income to get you a first-rate startup income,” says Morrissey.

“If you choose a product linked to the RPI and it rises by 5 per cent a year, it will take you 10 years to make up the lost ground and about 20 years before you collect the same income overall. As you would have received from a level product.

‘Of course, if RPI inflation was high, you would make up ground quickly, but low inflation means it takes you longer.’

He says that with annual income increases of 3 percent per year, it will take 12 years to earn the same income, so you will be 77 years old before you earn the same income.

And it will take about 21 years before you have the same gross income of around £144,000 from the level of output you have.

Morrissey says: ‘You have to think carefully about how long you’re going to live to make the best decision for you.’

Unless you have an existing health condition, or a family health history that you think could affect you, the answer to this is unclear.

But at least evaluating the numbers will give you a better idea of ​​the risks you run when buying an annuity with inflation proof or not.

Morrissey warns: “The inflation beast may be under control but that doesn’t mean it shouldn’t be a key factor in your retirement income planning.

You may be retired for 20 years or more, and even the most benign inflationary environment can curb your purchasing power during that time.

A period of double-digit inflation like we’ve seen recently can eat big chunks out of your plans, so it pays to be prepared.

He says you can consider other options, such as not taking your retirement all at once.

‘ Instead, you can annuitize to save guaranteed income in slices over time as you need it while keeping the rest of the investment where it can be expected to grow.

This way you also have the benefit of securing higher annuity rates as you age and if you create a situation where you qualify for an advanced annuity you can get a further boost in income which can help you to Help combat the effects of inflation over time. ‘

Why are annuities good value again?

Many people give annuities a different look. Sales last year hit their highest level since pension liberalization reforms in 2015 prompted many retirees to start living on investment funds in their old age instead.

An annuity provides guaranteed income until you die.

But they were abandoned for years due to poor prices and restrictive conditions, and after gaining a bad reputation on the back of annual mis-selling lawsuits.

Pension liberalization reforms have encouraged many savers to keep their funds invested and avoid withdrawals instead, despite the financial market risk involved.

However, the recent run of interest rates to fight inflation means that annuity providers can finance more attractive deals, leading to a resurgence in sales.

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

That doesn’t mean you have to decide on the best way to fund your retirement. Scroll down to find our tips on what to consider before buying an annuity, and check out the guides below.

> Read a 12-step guide to investing in your retirement

> Find out how to combine investment deductions with annuities

Fixed Rate Versus Inflation-Linked Annuities: How to Decide

Nick Flynn, Director of Retirement Income at Canadian Life, offers the following tips.

1. Consider how your annual income will change in the future

Inflation-linked annuities will generally have lower initial income than fixed-rate annuities, but this may change over time.

Some simple assumptions about the future direction of inflation will allow you to determine how your inflation-linked annuity will increase in the future, at what age your income will match your fixed annuity rate, and at what age. You are likely to get Earn more than you originally paid.

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

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

3. Consider your tax position

Make sure you consider your overall tax position and assess the tax implications of your annuity with any other income you receive.

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

4. Consider a mixed approach

Unless you have a very small pension pot, there will generally be more than one option available to you.

It may be that a blended approach—for example, a mix of fixed and inflation-linked annuities, or adding a drawdown element—gives you a better chance of meeting your retirement goals.

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

Shop around by getting quotes from more than one provider, and do some preliminary research to better understand your options.

Then talk to an established financial advisor who will be able to help you reach a decision that works best for your situation and needs.

What you should consider when buying an annuity

• If you wait to buy an annuity until you are older and your health has deteriorated you may be able to get an ‘advanced’ rate.

• You can rethink your investment and withdrawal strategy, and buy an annuity in tandem or later as an alternative source of income, but you can’t get out of an annuity after purchase.

• If you’re healthy, the best prices are on single life, not inflation-linked ‘level’ annuities, but recent life pressure costs show how important it is to get some protection against rising prices.

• If you buy a single, not joint, life annuity there will be nothing for your spouse if you die first, so consider what they will be living on and discuss it with them before making a decision. . Many widows and widowers find that their partner’s annuity leaves them with no income after their bereavement, forcing them to live on meager government benefits.

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