When does something relatively straightforward like RPI, a widely quoted measure of inflation, become complicated? The answer, when insurers and Annuity providers get involved.
Choosing to buy an Annuity with payments due to increase in line with inflation is often seen as the best way of maintaining the buying power of your income especially in these times of relatively high inflation.
If you are thinking of buying an Annuity linked to RPI, read on, it may not be as simple as you would expect.
It all seems pretty straightforward to begin with, you want to maintain the real value of your income, you therefore opt for an Annuity linked to RPI. The concept of RPI as a measure of inflation is pretty simple; however when insurers and Annuity providers get involved the situation gets a whole lot more complicated.
Most Annuity providers do not cap RPI increases. However, one provider, Just Retirement does place a cap of 5% on their RPI increases.
What happens if inflation is negative?
Whilst most providers do not cap their rises the picture is more confused here.
Annuity providers fall into three camps when it comes to the subject of deflation. Firstly there is a group including Prudential and Just Retirement who would reduce the level of income that your Annuity provides should we experience a period of deflation.
Secondly providers such as Aviva and Legal & General would not decrease the level of income; it would simply stay the same.
Thirdly a number of providers “reserve the right” to decrease the level of income in the event of deflation but did not do so the last time inflation was negative.
The following table shows more information for Annuity providers who offer RPI linked Annuities:
|Annuity provider||Would income reduce in the event of deflation||Are RPI increases capped?|
|Canada Life||“Reserve the right to do so” but did not last time inflation was negative||No|
|Just Retirement||Yes||Yes, at 5%|
|Legal & General||No||No|
|Partnership Assurance||“Researve the right to do so” but did not last time inflation was negative||No|
|Prudential||Yes||Depends on the option which is selected|
How much does RPI linking cost? Is it really worth it?
Most of us are aware that linking an Annuity to RPI will produce a lower starting income than if a level Annuity is selected. But just what is the difference and how do they both compare to an Annuity with annual increases of say 3%?
The following table shows for a typical Annuity how significant the reduction in starting income is if RPI linking is chosen as an option.
|Type of Annuity||Best quote, income per year||Provider||Annual reduction|
|Level||£6,093.36||Legal & General||–|
|3% annual increases||£4,104.24||Legal & General||£1,989.12|
|RPI linked||£3,346.68||Canada Life||£2,746.68|
The figures are based on a healthy non-smoking male, aged 65 with a £100,000 pension fund, assuming his wife is also a non-smoker, healthy, and 62 years old, a 10 year guarantee, 50% spouses pension with income paid monthly in arrears (Source: The Exchange 27th April 2011)
Whilst we would all like an Annuity which rises in line with RPI, for some the price in terms of starting income is just too great to pay.
What are the alternatives?
If you want to guarantee that your Annuity income will not fall in the event of deflation and that your rises will not be capped there are providers to suit you. Of course they also need to offer a competitive starting income.
Whilst an increasing Annuity will always provide a better defence against inflation than a level Annuity it can sometimes be unaffordable.
Start by seeing what level of indexation you can afford to build in to your Annuity. Use an Annuity Calculator to get quotes for a level Annuity and compare these with what you will get if you include annual increases. Can you afford to include any increases at all?
If the answer is ‘no’ you will probably have to opt for a level Annuity. However all is not lost, remember that your State Pension is subject to annual increases and for most people the State Pension is larger than their Annuity income. Also, for many people the breakeven point where the rising Annuity represents a larger total ‘payout’ than a level Annuity is many years in the future and for some will never actually be reached.