What are inflation linked (RPI) annuities?

If you are shopping for an annuity and are concerned about future rises in the cost of living then you may be attracted to what are known as inflation-linked annuities (also known as RPI annuities). This type of annuity is linked to the Retail Prices Index, which means your annuity income will move up or down inline with RPI inflation. This is the higher measure of inflation as it includes mortgage interest payments, which CPI inflation does not. If you are worried about future rises in inflation then an RPI annuity can be one way to protect yourself financially in the future. They can be particularly beneficial if inflation remains high for a prolonged period of time or you enjoy a longer than average retirement span.

Up until 2008 inflation had remained below 3% for over a decade, which means anyone who took out one of these annuities would only have seen a modest rise in their income. However since then inflation has increased to over 5% which would make these annuities much more lucrative.  However inflation can fall as well as rise and if inflation falls below 0% we get what is known as deflation which means your annuity income will not rise at all, in fact it will fall in line with the deflation as happened in September 2009.

As mentioned, to benefit in the longer term from an RPI annuity not only has inflation got to remain high but the individual would also need to live for a longer than average period in retirement, some estimate that a person would have to live into their 90′s or beyond for this type of annuity to outweigh other types of escalation. Remember there is no extra money with this type of annuity, just that your starting income will be around 40% lower. Some experts believe that a better option is to choose an escalating annuity, where the individual specifies the percentage amount of increase they wish to see in their income each year when they buy their annuity. It has been argued that RPI annuities present a risk for the provider as they do not know the future levels of inflation so may price this in accordingly with a lower starting income.