Inflation-linked versus level annuities – which annuity is best for you?

Annuities have enjoyed a real burst of popularity in recent years off the back of soaring incomes.

But most annuities bought are level products that don’t increase over time.

So, what’s the difference and which one could be right for you?

Remember, annuity quotes are only guaranteed for a limited time and will vary depending on individual circumstances. Rates can also change regularly and go up or down in future.

This article isn’t personal advice. The government’s Pension Wise service can help if you’re over 50 and need guidance. You can also get personalised financial advice if you’re not sure what’s right for you.

Level vs inflation-linked annuities – what’s right for you?

It’s understandable why people might be tempted to go down the level route – latest data from HL’s annuity search engine shows that a 65-year-old with a £100,000 pension can get up to £7,814 from a single life level annuity with a five-year guarantee.

This compares to £5,724 per year from an annuity that increases by a fixed 3% per year.

These quotes were generated on 15 May and compare the rates available from the UK’s leading annuity providers. All quotes are based on an average postcode and paid monthly in advance.

But, with retirement potentially lasting twenty years or more, inflation does need to be taken into account.

We don’t need to see the blockbusting levels of inflation of recent years for it to have an impact. Even relatively low inflation over time will nibble away at your purchasing power and could mean your budget gets increasingly stretched over time.

This means that even though escalating annuities offer a lower income at outset, the fact they increase every year can offer valuable reassurance, alongside any State Pension you get, which increases in line with the ‘triple lock’.

However, how long will it take for the income from that escalating annuity to reach that of the level one?

A 65-year-old would need to wait until they were 76 to get an income exceeding £7,814, based on the same assumptions used above.

They would then have to wait until they were 85 before the total income from the escalating annuity outstripped that from the level one.

Thinking of buying an annuity? – What you need to consider

Whether you’re thinking of buying an escalating or level annuity, it’s important to do your research. Especially as once you buy one, you can’t just undo it.

So, don’t just accept the first quote you’re offered.

Different providers offer different rates and taking the time to look across the market could leave you thousands of pounds better off over the course of your retirement.

It's also important to include as much information about your health and lifestyle as possible as part of your annuity application.

If you suffer from a medical condition, even if it’s being treated, then you could qualify for an enhanced annuity which will give you an increased income.

Even including data like how much you weigh, whether you drink, or if you’ve ever smoked could mean you get more from an annuity.

You can use an annuity search engine to get a sense of what’s on offer and make sure you get the best type of annuity for your needs.

You also don’t need to annuitise all your pension at once. You can annuitise in stages as you go through retirement.

This means you can annuitise to secure your essential needs and keep the rest of your pot in income drawdown where it has the opportunity to grow – although this isn’t guaranteed.

And as you annuitise more, you have the potential to benefit from higher annuity rates as you get older.