What price an index-linked pension?

People are often shocked at just how much an index-linked annuity costs relative to one that pays a level income for life.  Imagine if you will, you have a £100,000 pension pot that you are seeking to convert into pension income.

According to the Daily Telegraph, Aviva will exchange your £100,000 pot for a lifetime annual income of £5,448.  However, if you were to require a 5% increase each year, your starting income would be just £2,815, almost 50% less.

That begs the question, how long would you have to live before you “broke even” on your decision to opt for the escalating income?

A simple spreadsheet shows that you would have to live until you were 90 to have been paid as much from an escalating pension as you would have received from the level annuity. By that point though the escalating pension pays you an annual pension of £9,532, whilst the level annuity would, of course, remain at £5,448.  Thereafter the escalated pension moves ahead quite quickly. Indeed by the time you receive your telegram from the Queen (or King) on your 100^th birthday, you would have received a total of £73,000 more from an escalating annuity.

For context the average male retirement age is 64.6 years and life expectancy at that point is 83.5 years.

Of course the real world isn’t quite this simple. Inflation, for example, invariably means that a pound received early on is worth more than one received twenty years later. Also most annuities make some sort of provision for surviving spouses. Over the next couple of updates I will delve into a few of these complexities. Even if you don’t intend to buy an annuity, inflation is still something that you will have to take account of to ensure that your savings last for your entire retirement.

Take care out there

PensionMan