RPI Linked Annuity or Level-Annuity?

BlueTree

Hi,

I am asking a question of behalf of a family member -

They are reaching retirement age soon and plan to convert a small pension into an annuity.

They have been given an rpi-linked annuity quote and a level annuity-quote, and are not sure which would be the best option.

After a 25% tax free lump sum, they were quoted -

RPI LINKED 1ST YEAR - £491 pa
LEVEL ANNUITY - £909 pa


Now, assuming an annual inflation rate of say 5%, the level option looks best for the next 20 years? Would that be right?

BlueTree

Does anyone have any thoughts?

twokcc

Had to make same decision 18months ago and i decided to go with level annuity.
2 other things to consider
1) How much to guarantee 10yrs payment- took this option made a very minute difference to yearly payment.
2) could annuity be enhanced because of any medical condition- mentioned by my financial advisor. I take tables for hypertension (high blood pressure) and because this is under control didn't consider it to be a medical condition. may have not made any difference just wished I had explored this option.

Old_Slaphead

BlueTree wrote: »

Hi,
Now, assuming an annual inflation rate of say 5%, the level option looks best for the next 20 years? Would that be right?

Breakeven at 5% would be 24 years and 4% about 30 years - however after 24 or 30 years then you would be losing out big-time (ie around £1000+ pa).

Personally I would take level (assuming pension starting at 60-65) - tho' that shouldn't be taken as advice or recommendation

Acromion

Carpe diem.You are more likely to be able to enjoy the extra money from a level annuity now than in 20 years time when you may be dead or moribund.
If you have index linking as part of the of old age or final salary pension that's a real bonus but the cost of paying for it privately is prohibitive.

Linton

As with all retirement planning, I would start with income needs:

From the plan you should know the income to provide the desired standard of living and the lower income required to meet basic needs.

I would want to ensure that the basic need is met by indexed linked income. This will be mainly state pension(s), however I would guess that although twice the state pension may be sufficient for 2 peoples basics, a single pension wont cover 1 person. So there may be a need for further index linked income, particularly after the death of one of a couple.

Once the basic needs are met by index linked income, the rest up to the desired standard of living income could be provided by a mixture of fixed annuities, drawdown or even index linked annuities if you have plenty of spare pension funds.

For anything above the desired standard of living I would want the flexibility of drawdown to give the option of minimising tax.

Note - I would see the purpose of index linked income as being to ensure that you dont fall into poverty as a result of short periods of very high inflation, rather than dealing with normal inflation of say 3%. IMHO the latter could better be handled by phased fixed annuities.

Loughton_Monkey

I have looked at these things personally. There is no 'black or white' answer, because to do a straight mathematical calculation, you have to make inflation assumptions. But what I have found is that the inflation assumptions that make this type of annuity 'win' seem to be pretty unrealistic.

Remember, though, that you will get 'false readings' by simply calculating on an 'average' 5% or whatever. Just see what a couple of years (earlier on) of 9% - 12% inflation, settling down to 2% - 3% can do. OK, an average of 5% over the period, but an absolute 'killer' for spending power.

Of course if we ever return to the inflation of the 1970's, then many of us would be pig-sick at not having chosen RPI-linked. But I tend to think that is unlikely.

Best strategy, probably, is to take the level annuity - but recognise that it will never go up, therefore only spend a proportion of it, saving up the rest for later. Possibly continue to invest £3,600 (£2,880 net) into a small pension even in retirement. This is the maximum on which you can get tax relief with no earnings.

BlueTree

Thanks for your thoughts and opinions!