Mr E.C. Asks:

I have received some annuity quotes from my Pension provider and whilst I would ideally like the income to increase each year to help protect it against inflation the initial income they are quoting is a lot lower.  What would you suggest?

Peter Sharratt Answers:

Logically it makes sense to opt for an increasing Annuity but this does mean that when compared to a Level Annuity (one that does not increase) you will get a lower income initially. However, the income that you get will increase each year in payment and eventually it will equal that of the Level Annuity.  But, assuming you selected an Annuity that increased at a fixed 3%pa it would typically take about 13 years for this to happen.

This means you will have to wait for 13 years to get the same income from the Increasing Annuity that you could have had from the Level now.  During the previous 13 years the Level Annuity was actually paying you a higher income although as time goes on the difference each year does diminish.  To do an accurate comparison between the two we need to calculate how long it will take for the accumulated income from the Increasing Annuity to equal the accumulated income from the Level Annuity.  Scarily it is nearly 27 years which means that if you retire at 60 the increasing Annuity will not represent better value until you are 87.

You do need to consider that the actuaries are telling us that we are all living longer but based on these figures I would find it hard to recommend the Increasing Annuity.  An alternative solution could be a With Profits Annuity as the income from this type of Annuity can increase depending on the performance of the underlying With Profit Fund.  Equally though the income can decrease although there will normally be a minimum guaranteed income.  As a final point please be aware that you do not have to buy your Annuity from your existing Pension Provider; you can shop around to try and get the best Annuity rate for the type of Annuity that you want to purchase.

Knowing that the difference between the best and worse can be over 20% should be a good incentive.  An Independent Financial Adviser will be able to review your options fully.

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Please note: answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made.