Would you rather have a set fixed income for life or one that starts lower but is protected from the ravages of inflation?
It’s a dilemma faced by growing numbers of retirees who are buying an annuity to take advantage of rates that are hitting levels not seen for close to two decades.
But new research by pension company Standard Life suggests that the sweet spot may lie somewhere in between.
An annuity is where you use your pension pot to buy an income that lasts for a fixed period or for the rest of your life. Most people who buy an annuity opt for a version that pays out the same amount year after year.
But some opt for one that has inflation protection built in. These pay out a smaller monthly sum at first, but that increases over time in line with the cost of living.
Researchers at Standard Life looked into which option would leave you better off – a level annuity, one that rises with inflation or buying a series of annuities throughout your retirement.
Sweet spot: Would you rather have a set fixed income for life or one that starts lower but is protected from the ravages of inflation?
It considered a 65-year-old with a pension pot of £150,000 who lives to 90. If they purchased a level annuity, they could get an annual income of £10,151, which would total £253,775 over 25 years.
If they bought an annuity with inflation protection, they would receive just £6,565 in the first year, but this would rise to £15,515 by the time they reach 90. That would give them a total income of £255,706, assuming 3.5 per cent annual inflation.
For the third option, researchers looked at what would happen if the 65-year-old bought a level annuity with £90,000 at retirement and kept the remaining £60,000 invested. Then, every five years until the age of 80, the retiree took £20,000 from their pension pot to buy another annuity.
In this scenario, the 65-year-old would receive a starting income of £8,155 but this would rise to £12,065 by the age of 80.
Over their retirement, they would receive a total income of £259,115 – more than if they had opted for a single level annuity or one with inflation protection.
Pete Cowell, head of annuities at Standard Life, says: ‘A combination of different solutions can often better meet people’s needs.’
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