Escalating Annuity

Escalating annuities are annuities that increase by a specific amount of escalation which is pre-determined by the annuitant at the time of purchase. Unlike level or standard annuities, which pay the same amount each year until death, an escalating annuity will increase each year. When you buy one of these annuities you will have the option to choose the desired level of escalation, such as 1%, 2% or more. What should be recognised here however is that there is no ‘extra’ income, this is just deferring your money as your starting income will be lower compared with a conventional annuity. The reason why people choose escalating annuities is that inflation reduces real terms spending power over the lifetime of retirement. If inflation is high for a long period, then your income in real terms will see a substantial reduction. As you will be retired increasing your income may be difficult as you will no longer be in work. This may mean that you will have to supplement your income by other means such as downsizing your home or releasing the value of your property by taking out equity release.

Another option is to hedge your bets and opt for what is known as an inflation-linked annuity. Instead of a specific level of increase each year, your income will be pegged to the annual Retail Prices Index or RPI for short. If inflation remains very high for a prolonged period and you also live longer than average in retirement, then an RPI annuity could make financial sense. However, generally they are seen as less beneficial compared to regular escalating annuities. As one pension expert once put it…”…you’d have to be terminally pessimistic on inflation and exuberantly optimistic on your life expectancy to buy an inflation linked annuity”. Escalating annuities can be bought on a single-life and joint-life basis, with the income likely to be lower if bought as a joint-life annuity. Although it can be tempting to take the maximum starting income as offered by a level annuity, retirement spans are getting longer and longer and what you can buy with your starting income in 2012 is going to be vastly different from how far it will go in 20 or 30 year’s time.