An indexed-linked annuity, sometimes referred to as an inflation proof annuity is one which is linked to the Retail Price Index (RPI). Each year official inflation statistics are recorded, which are then used by pension providers to work out if the income of those annuitants that have an indexed-linked annuity should increase, decrease or remain the same.
The reason why Indexed-linked annuities are attractive to some retirees is that the income from a standard pension annuity can be eaten into by rising inflation, as the annuity rate that is offered will be fixed at the same level for the entire annuity payment period. By choosing an Indexed-linked annuity, you are able to protect yourself against future rises in inflation. One thing to note is that when you take out one of these products, your starting income will be significantly lower compared to a lifetime annuity for example, around 40% lower in some circumstances.
Another thing to consider with regard to an indexed-linked annuity is that the RPI is only one way of recording the inflation figure. Some people say that a more accurate way of measuring inflation is by taking data from the Consumer Price Index (CPI), which includes a number of factors which are excluded from the RPI, such as the cost of mortgage payments for example. Inflation would also have to run at a relatively higher level for a prolonged period for annuitants to benefit financially from an indexed-linked annuity, around 5% according to some estimates. But the biggest danger is not that you won’t benefit at all and that you could be worse off. If there is a period of deflation and prices fall, the RPI will show as a negative as your retirement income will go down.
