What affect will inflation have on my annuity?

When choosing an annuity it can be very tempting to opt for a level annuity because income starts at a higher level. However, inflation reduces the purchasing power of money and if your income does not increase then then you will not be able to buy as much year on year. 

Choosing an indexed annuity can overcome this problem. The income starts lower but this may be at a time when you have other income (e.g. part time earnings) or you can get used to a tighter budget. Your income will then maintain its purchasing power much longer.

There are two types of inflation proofing; a fixed percentage (e.g. 3% or 5% pa) or a dynamic percentage that links to the retail prices (RPI). With fixed inflation proofing there is benefit when inflation is lower than the level of inflation proofing (in real terms your income increases), the opposite is true when inflation is higher than the fixed level of inflation protection (income falls in real terms). It is impossible to predict long term inflation, so linking your annuity to the RPI index should offer the best overall protection. 

The following calculator will show the effect of inflation on a level, 3% and 5% escalating annuity. This is not an annuity quotation, rates are not guaranteed.