Inflation proofing and level annuities- What are they?
Inflation can be a huge factor when comparing annuities. This is especially true in the case of a long term fixed annuity.
Fixed annuities will pay you a set amount each month, never increasing over time. So where a McDonald’s cheeseburger would have cost 59p 5 years ago, they now cost 99p. The cost of living increases over time, this is known as inflation.
The history of the economy shows that the purchasing power of money declines as time goes on. Money no longer buys as much as it used to, this will become increasingly evident in the case of a long term fixed annuity.
A common issue with fixed income annuities is that you continue to receive the same amount of money but can subsequently afford less and less.
A solution to this problem is an ‘inflation proof annuity’. An inflation proof annuity is a name given to an index based annuity that increases and decreases your monthly payments based on the retail price index (RPI). This is considered as one of the most accurate indicators of the current value of money. This starts with a basic payout amount and has a preset interest rate that gradually increases the payout. So when the RPI increases, so does the interest rate and vice versa, meaning, if the RPI rate decreases so would the interest rate.
With the annuity market offering you many different options there is sure to be one to fit your financial needs and financial goals. However, the inflation proof annuity could be better suited to long term retirement or estate planning purposes, as one of the main advantages of this annuity is the reliability of the regular schedule of payouts. With these payouts automatically adjusted to the inflation rate, this feature becomes even more attractive.
Thinking of Retiring Soon? Have a look at our Annuity Comparison Table
These annuities provide a variety of advantages over fixed rate ones. Firstly, they provide an income for the rest of your life and protect the buying power of your income. However, there is no getting away from the fact that your money is going to buy less in the future than it is going to buy today. However, an inflation proof annuity is one of the best ways to try and protect your investment from this problem.
Even though conventional annuities with fixed annual increases do offer protection from the effects of inflation, they do not protect you against inflation if it starts to rise very quickly. The income you receive before tax will therefore always keep its real value throughout your retirement.
There are also some disadvantages to this type of annuity; for example, you would start off on a lower income than you would with a fixed rate annuity. If inflation falls below zero your annuity payments may be reduced with some providers, unless you were to take out a guarantee against negative inflation at the start; though these guarantees will affect your rate further still.
With people now tending to live for longer during retirement, even low levels of inflation can significantly reduce your income in real terms over a significant period. By providing the annual changes in line with the retail price Index (RPI), or an equivalent index chosen by the government, this annuity option could ensure your income maintains a semblance of its buying power.