If you’ve decided to buy an annuity, the next big decision is what type to go for. With inflation still elevated, an escalating annuity, which rises by a set amount or in line with inflation each year, might seem the obvious choice. However, the type of annuity that is best for your circumstances depends on a number of other factors, so a level annuity could still be the best option.
Escalating annuities offer much lower starting incomes than level annuities. Ian Cook, chartered financial planner at Quilter, notes that, for example, £100,000 might buy a 65-year-old a level annuity that pays out £6,380 a year; a 3 per cent escalating annuity that pays out £4,870 in the first year; a 5 per cent escalating annuity that pays out £3,764; or a retail price index (RPI)-linked annuity that pays out £4,105, as of 5 June. “It would take the 3 per cent escalating annuity about 11 years to catch up with the level annuity and the 5 per cent escalating annuity about 12 years to catch up,” he explains.
While the level of income is ‘catching up’ you are missing out on money you could have had, and to recoup this would take many years longer. You need to live for however long the ‘catch-up’ period lasts just to start getting the same amount the level annuity pays. If you don’t expect to live that long, a level annuity might be better and, if you have certain health conditions or smoke, you might qualify for an even higher annual payout from a level annuity.