Will Inflation Eat Away Your Annuity Income?

October 23rd, 2011

Following many months of relatively high inflation in the UK, it would be surprising if retirees are not concerned about the diminishing buying power of the income that they receive from their fixed annuities.

Whilst the cost of heating your home and food prices have all risen dramatically, interest rates payable on savings have more or less flat-lined.

Although the Bank of England expects the rate of inflation to fall significantly in 2012, even the long-term targeted inflation rate of 2% will still have a negative effect on fixed annuity incomes over time.

If you have not yet bought an annuity, did you know that it is possible to buy a retirement annuity that has an income that rises each year?

It has been common practice in the UK for people to buy an annuity at retirement with their pension funds.

The default choice for most people is to choose a fixed income rather than one that increases each year.

It is thought that the main reasons for this are that either their existing provider didn’t quote an increasing income option and so they chose from the only options quoted (because they didn’t know better) or that they compared the difference in starting income between a fixed annuity and increasing annuity and decided to go for the usually much higher fixed income option without fully understanding the implications.

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Example of the difference in initial income between a fixed annuity income and increasing annuity income

In September 2011, a male aged 65 with a pension pot of £50,000 could have bought a single life annuity (no guarantee period) that would have paid out a fixed monthly income of £282.

If, instead, he opted for an annuity income that increased at 3% each year, he could have received £212 per month.

Using these example figures, it would take around 10 years for the income paid by the 3% increasing annuity to catch up with that paid by the fixed income annuity.

However, it would take approximately 19 years before the total accumulated income paid by the 3% increasing annuity exceeded the total income paid by the fixed annuity.

According to figures issued by the National Office of Statistics in June 2011, a man aged 65 has a life expectancy of approximately 18 years. For a woman of the same age this rises to 20 years.

You can see from the above, that the decision about whether to buy an annuity with a rising income is a tough one to make.

Do you “live for today” and take the higher fixed income or “play the long game” and take the rising income? Do you expect to live long enough to benefit from the rising annuity income option?

If you talk to an independent pension adviser, they can discuss all the pros and cons of fixed income and increasing income annuities and provide you with advice regarding the best option to choose for you.

Remember, that once you’ve bought your retirement annuity, usually it can’t be altered. So, make sure that you don’t get tied into the wrong type of annuity for the rest of your life!

If you live in the UK or have pension funds in a UK pension scheme, you can find out more about retirement annuities and how to buy an annuity by visiting http://www.pensionchoices.com/.

Annuity Choices Ltd operates the website www.pensionchoices.com, which contains up to date information about the retirement and pension options available to retirees in the UK. The site also contains links to various advisers who can help you to make the most of your pension funds at retirement.
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Will Inflation Eat Away Your Annuity Income?

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