What is an escalating annuity?

Category: Retirement
Author: Tim Leonard
Updated: 07/03/2018

When choosing your annuity, you will need to decide whether to have a level or increasing (escalating) income.

An escalating annuity option pays you an increasing income each year either by:

• Following changes to the Retail Prices Index (RPI), which is why you may also hear an escalating annuity being referred to as an inflation linked annuity

or

• A fixed rate where your annuity income goes up by a set amount, for example by 2% or 3% per year.

An escalating annuity pays less at the start, but more later on

An escalating annuity will pay you a lot less at the start than a level annuity. However, your income will increase every year and could eventually outstrip the level annuity – but only if you live long enough.

It will take quite a few years for an escalating annuity to 'catch up' with a level annuity, and a good few years more before you will have received as much income. Maybe as many as 20 years.

Inflation linked annuities

The advantage of an inflation linked annuity is that your income will maintain the same spending power.

An annuity that increases by a set amount will struggle to maintain spending power, if the rate of inflation is higher than the rate it increases by.

For example, if your annuity increases by a set amount of 3% per year, and inflation is higher at 4.5% - it may not seem possible now, but in the long term, it could get back to that stage - your annuity will actually lose spending power.

On the flipside, if inflation is less than your set increase of 3% per year, your annuity income will actually grow in terms of spending power.

Find out whether an escalating annuity will pay you a better income in retirement by comparing Annuity Rates