Should I choose a level or indexed annuity?

When choosing an annuity it can be very tempting to opt for a level annuity because income starts at a higher level, usually about 30% more than an indexed annuity. Over time a problem arises as inflation reduces the purchasing power of money. 

Choosing an indexed annuity can overcome this problem, but your income will start at a lower level. This may require some belt tightening but you will get used to spending less and your income will maintain its purchasing power much longer.

There are two types of inflation proofing; a fixed percentage, say 3% or 5%pa or one that is linked to retail prices (RPI).

If real inflation remains below the annuity's fixed level of inflation proofing then income will rise in real terms. Unfortunately, it is impossible to say what inflation will be in the coming years, so a better option is to link to RPI which increases or decreases according to the Retail Prices Index. Inflation could rise dramatically and this option would give you the best overall protection.

The following calculator will show the effect of inflation on a level, 3%, 5% and RPI linked annuity. You will notice that the RPI linked annuity always displays a flat line - this means it is retaining its purchasing power. The other annuities will either rise of fall in value according to the inflation rate entered. (If one line disappears it's because it is hidden by another)