I’ve been looking into buying an annuity and an escalating annuity comes up time and time again. I was just wondering what an escalating annuity is and whether it’s the same as an index-linked annuity?
- Neil Adams
- Head of Pensions
What is an Indexed Annuity?
You’re right in that an escalating annuity is the same as an indexed annuity or an index-linked annuity.
To go back to basics, an annuity is a regular income you receive after retirement. You buy this income by exchanging your defined contribution pension pot for an annuity when you decide to stop working.
How much income you’ll get from an annuity is based on your annuity rate. This is determined by a number of different factors, including your age, location, smoker status, whether you have any medical conditions and of course the size of your pension pot.
Something else that will have an impact on your annuity rate is whether or not you opt to index-link your annuity. When you choose an escalating annuity, you’re opting for your pension income to rise over time in line with inflation. This is to prevent a fixed retirement income being eroded over time as prices rise.
Consider that annuities are typically long-term financial products that you may be receiving income from for decades. Then consider how much a pint of milk cost 30 years ago compared with now — it’s almost doubled from 23.9 pence in 1986 to 42.7 pence by 2016.
When you buy an indexed annuity you typically receive a lower initial income, but this is to compensate for the fact that your pension will increase in the future along with inflation.