What are escalating annuities?
Escalating annuities offer retirees the chance to build in a set percentage of escalation into their annuity income. When purchasing an escalating annuity you will be able to specify by how much you want your income to increase by each year. This percentage increase is normally somewhere between 1% and 5% and must be decided at the time of purchase. If you do choose this form of escalation it is worth bearing in mind that your starting income will be lower as a consequence as you are in effect deferring your income. This can be a suitable option for those annuitants who are concerned about the impact of rising inflation. If you consider that if inflation remains at even a moderate level of 3%, over 20 years your starting income will in real-terms be worth a lot less compared to when you bought your annuity. Moreover it is also worth noting that in recent years prices for certain goods and services have risen at above inflation levels. For example energy, fuel and food have all risen sharply throughout the recession, leaving those on fixed incomes (mostly pensioners) having to deal with these rising costs. Although it can be tempting to take a level annuity as it offers the highest starting income, it can be worth considering escalations especially if you are classed as a younger retiree and are likely to live longer retirement.
If you are concerned about inflation then you could opt for what are known as inflation-linked annuities. These allow annuitants to tie their escalation level to the Retail Prices Index, which is the official government measure of UK inflation. If inflation is high for a long period you could end up benefitting from choosing this type of annuity. This would only happen though if inflation was high over a very long period of years and in addition you ended up living for a long time in retirement. You can also build in death benefits to your escalating annuity if you wish to pass some or all of your income onto a partner or spouse should you pass away before them.
We recommend you consider carefully the issue of inflation as retirement spans are increasing year by year. Back in 2010 the average number of years in retirement was 23 years for a woman and 18 years for a man, whereas after the second world war people were only expected to live perhaps 2 or 3 years in retirement.