Level vs escalating annuity
Level annuities pay a higher initial income, but escalating annuities can offer stability in the face of inflation.
What is a level annuity?
A level annuity gives you a fixed retirement income that stays the same for the rest of your life. That means you’ll get the same amount each year, regardless of inflation.
You’ll get a higher income to start compared to an escalating annuity, but the value of your income will fall as prices rise over time.
What is an escalating annuity?
An escalating annuity is a retirement income that goes up every year. You might go for an escalating annuity if you want to avoid inflation eating into your buying power over time.
There are two main kinds of escalating annuity:
- Fixed escalating annuity: an income that rises by a fixed percentage you choose when you start your pension.
- Index-linked escalating annuity: an income that rises in line with the Retail Prices Index (RPI), a common measure of how the cost of goods and services changes each year.
If you buy an index-linked escalating annuity and the RPI is negative in any given year, we keep your income the same instead of lowering it.
Both kinds of escalating annuity mean you take a smaller initial income than a level annuity which then increases over time.
What are the key differences between a level and escalating annuity?
Here are the main differences in a nutshell:
| Level annuity | Escalating annuity |
|---|---|
| Fixed income for life. | Income increases as time goes by but is lower to start. |
| Higher risk of inflation eating into the buying power of your income. | Lower risk of inflation eating into the buying power of your income. |
| Doesn’t change with inflation or price changes. | Increases as prices rise and stays level if they fall. |
The biggest difference between a level annuity and an escalating annuity is how they look long term.
| Annuity type | Initial income | Break even | Total return break even |
|---|---|---|---|
| Level | £3,390 | - | - |
| 5% | £1,850 | Year 15 (£3,500) | Year 23 |
| RPI | £2,230 | Year 15 (£3,480) | Year 23 |
Aviva annuity rates at 17th January 2025. Assumptions are based on a 65-year old customer with a pension of £50,000. Assumes an average RPI of 3.5%.
In this example it takes 13 years for the initial income from an escalating annuity to match the income from a level annuity.
And it takes 23 years for an RPI-linked annuity, and 23 years for a 5% fixed, to return the same overall amount as a level annuity.
You should shop around for the best deal for you because different providers may pay a higher income.
Is a level or escalating annuity right for you?
Choosing a level or escalating annuity will depend on your priorities and what you value most in retirement.
If you’d prefer a higher income when you first retire, a level annuity could be right for you.
But if you’re worried about inflation and want an income that can keep up with rising prices – and you can accept a lower initial income in exchange – you might choose an escalating annuity.
And if you’re still scratching your head, pension advice could help. If you don't have an adviser, you can find one at www.unbiased.co.uk. You'll have to pay for this advice. Or you can get in touch with our experts below.
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