Annuity Hound

Inflation erodes the purchasing power of money. Escalating annuities provide regular increases in annuity payments designed to keep up with or at least mitigate inflation. In reality, this is really just a form of deferred income as initial annuity payments will be significantly below normal annuity rates to compensate for higher than normal rates in the future.An alternative to an escalating annuity for hedging against inflation is to purchase an index linked annuity. These were traditionally backed by indexed linked gilts but these debt instruments are now in very short supply. A more common solution of recent has been to use Sterling inflation swaps as an alternative means of backing purchased annuities.

Swaps are a type of derivative instrument and so careful consideration needs to be given to whether this is the most appropriate backing for an investment which is intended to be very conservative and provide a risk free retirement income.

As with escalating annuities, index linked annuities are relatively expensive and in April 2007, an index linked lifetime annuity for a 60 year old would provide less than 70% of the income that a flat rate or normal annuity would provide.

The cost benefit between escalating annuities and index linked annuities is based on the fixed interest market and market interest rates and depending on these factors, either could provide better value.