Should I choose a level or escalating annuity?
When approaching retirement, there is an important question that is likely to come up when purchasing an annuity… should I choose a level or escalating annuity?
What is an escalating annuity?
An escalating annuity does what is says. It increases your retirement income year on year by a couple of different options:
- Increase in line with the Retail Prices Index (RPI), often also called an inflation-linked annuity.
- Or, an agreed fixed rate such as 2 or 3%.
What are the differences?
An escalating annuity will pay a lot less at the start than a level annuity and will take a good while before it catches up with the income paid on a level annuity.
It will then take even longer before the comparable income paid by the escalating annuity overtakes the income paid by the level annuity.
So, what is the advantage of an escalating annuity
If you take an inflation-linked annuity, you are always going to keep up with the rate of inflation, meaning that your income won’t be eroded by the rising costs of living.
Disadvantages of the fixed rate escalating annuity
Even though a fixed rate annuity increases at a set rate, you could still find your income eroded if the RPI increases at a greater rate than your fixed rate. Eg. If your increase rate was set at 2% and the cost of RPI was 3.5%, your retirement income will be eroded by that rising cost of living.
On the flip side, if your fixed rate increases at a greater rate than RPI, you will find your retirement income going further.
Drawbacks of an escalating annuity over a level annuity
The main drawback in taking an escalating annuity is the time that you might actually live. If you were to die early, then you would have been better off having taken a level annuity. However, if you were in good health, it would be a good idea to consider an escalating annuity to ensure that the income you buy today would also be able to support you in the future.
To compare annuity rates, simply fill in your details and get a quote for both level and escalating annuities to see the difference.