inflation proof or not?

shiredeon

As i'm considering purchasing an enhanced annuity with my H lansdown drawdown fund which is only 78k at the moment, should i get an inflation proof(maybe) escalating annuity?, my first instinct was to get a flat one to increase the payments however i'm getting second thoughts if this is the right decision, i'm not opting for a guarantee period as it serves no purpose for me.

Any suggestions gratefully received.

jamesd

It's unlikely to be sensible to buy an escalating annuity in your situation:

1. In general, it takes close to normal life expectancy before an escalating annuity breaks even with a level annuity even if all of the income is spent. That time can be extended by investing some of the income, say half, and using the income from that to provide DIY escalation. Since you can do this investing within a S&S ISA you can gradually make the income tax free as inflation causes the income tax allowance to rise to include more of the ongoing level pension income.

2. If you qualify for an enhanced annuity your life expectancy is shorter than average because that's what makes enhanced annuities possible. So escalation is somewhat less likely to make sense than usual.

If buying an annuity it's likely to pay to get a pension liefetime annuity with 75% of the money ad take the 25% tax free lump sum. that lump sum can either be invested in a S&S ISA or used to purchase a "purchased life annuity". Those have somewhat better tax treatment because part of the income is treated as return of your purchase price and is tax free.

Level annuities are by far the most commonly purchased type. I forget the exact percentage but if I'm recalling correctly it's more than 90% of all annuity purchases.

It's also worth considering whether buying an annuity is right. It's a particularly lousy time to be buying at the moment.

You wrote that your fund is 78k at the moment. Are you expecting this to increase? There are "scheme pensions" that can have an actuary work out life expectancy for an individual and pay out more than the usual income drawdown limit based on that. £78k is rather low for those because of the higher costs but if there's more money to come it might be a useful option.

shiredeon

Thanks Jamesd
You've helped me to realise my original thoughts were correct, i already have an annuity(50K) which i bought before i left uk, pays me around £300 monthly,

Don't think i can take tax free cash coz i already did that when i put it in drawdown with H, lansdown, the main reason for buying an annuity is the dividends from the shares are sporadic and don't amount to much probably because of my somewhat disastrous share choices that the sages on M, fool helped me to choose, hehe, although the monthly payments are only gonna be around £400 that buys quite a lot in the philippines.

I don't expect my fund to increase much, i've switched a few things, kept my lloyds bank for sentimental reasons,(paid 6k+ now worth £300) but i'm gonna try to make it 80k before i jump.

Thanks again.

kidmugsy

I may have a blind spot here, but I've never seen the point of an escalating annuity. Fixed, yes; inflation-linked, yes; temporary, yes; but not escalating. What am I missing?

shiredeon

inflation linked, escalating, it's just another way of saying the same thing, or at least that's what i think kidmugsy.

chris1

kidmugsy wrote: »

I may have a blind spot here, but I've never seen the point of an escalating annuity. Fixed, yes; inflation-linked, yes; temporary, yes; but not escalating. What am I missing?

Escalating as an alternative to index linked -
index linked depends on the governments' official RPI figures which
a) can be manipulated
b) can go down as well as up, and
c) never seem to reflect the actual price increases for everyday expenditure...

At least with escalating it can't go down...
Of course, I could be missing something here as well - perhaps someone else will be along soon...

kidmugsy

chris1 wrote: »

Escalating as an alternative to index linked -
index linked depends on the governments' official RPI figures which
a) can be manipulated
b) can go down as well as up, and
c) never seem to reflect the actual price increases for everyday expenditure...

At least with escalating it can't go down...
Of course, I could be missing something here as well - perhaps someone else will be along soon...

You can buy I-L annuities that don't go down when RPI goes down, so that resolves (b). (c) cuts both ways - RPI often seems to me to exaggerate inflation. (a) you have to live with.

But that's all secondary - I repeat, what on earth is the point of an escalating annuity? For many years it will pay you less than a fixed annuity, but it still won't protect you from (for instance) a 1970s-style inflation. it seems the worst-of-all-worlds choice.

hugheskevi

I can think of two advantages of fixed-rate escalation:

(1) If you are close to a key tax threshold (either the point at which you start to pay income tax or the point at which age-related allowance starts to be tapered away or the the thresholds for higher rate tax and beyond) then an escalating annuity might permanently keep you just below the threshold whereas a flat rate annuity might initially put you above the threshold, falling below it in later years. Given the pay-off is immediate, the risk that inevitable policy changes will unwind the advantage isn't that great. That along with playing with State Pension deferral could manipulate tax position advantageously.

(2) Fixed-rate escalation reshapes the annuity, giving less in early years and more in later years compared to flat-rate. That means that if you think you will live longer than normal, the escalating annuity is likely to give more overall. But, if that is the case I'd expect annuity rates to reflect the adverse-selection.

jamesd

hugheskevi wrote: »

That means that if you think you will live longer than normal, the escalating annuity is likely to give more overall. But, if that is the case I'd expect annuity rates to reflect the adverse-selection.

Right. That's part of why they tend to be bad deals. Add in also the limited market size that reduces competition.

kidmugsy

"(1) If you are close to a key tax threshold..": that's an interesting point, but you could probably get the same effect either by annuitising in bits, or by annuitising into a combo of level and inflation-linked annuities. Or, indeed, by annuitising a bit and leaving the rest of your capital for your widow to annuitise.