UNDERSTANDING INFLATION RISK

It’s very important to take into account inflation risk with an annuity. An annual income of £7,200 might sound attractive now, but it will gradually lose its buying power. After 20 years of 2% inflation that £7,200 would effectively be worth just £4,800. It’s possible to buy an annuity which rises each year in line with inflation, but they start at a much lower level. Currently this would be around £4,500 for a 65-year-old. This is a significant drop, but if you’re concerned about the security of your income, then protecting it from inflation will also likely be high on your list of priorities. There are other protections you can build into an annuity, such as a spouse’s pension, or a guaranteed payment period, but again these will reduce the starting value.

You may be able to get a boost to the annuity as a result of health or lifestyle conditions, such as diabetes, elevated cholesterol levels, or being a smoker. Of course, the higher income the insurance company is willing to pay in these circumstances is based on a higher statistical likelihood of an early death, so even here it’s worth considering the total value of all the payments that might be made.

Annuities are unlikely to recover their former glory, mainly because they look so inflexible compared to the other options now on offer. But retiring pension savers should at least consider the pros and cons. It’s also worth remembering you can take out an annuity with some of your pension while keeping the rest invested. This mix and match approach might help you hit the perfect blend of security, flexibility, and growth.

AJ BELL