An index linked annuity increases the income each year in line with a measure of inflation, rather than paying the same cash amount for life. The protection is real and it is paid for at the start: the opening income is materially lower than a level annuity from the same pot, and understanding that trade is the whole decision.
Why the starting income is so much lower
The insurer is promising a rising stream of payments rather than a flat one, and it has to fund the increases from the same capital. It does that by starting lower. The size of the reduction depends on the inflation measure used, whether increases are capped, and the age at purchase, and it is usually a large proportion rather than a small trim. That gap at the start is not a charge; it is the same money arranged differently over time.
The crossover, and why it is not the whole answer
Because a level annuity starts higher and an index linked one rises, there is a year at which the index linked income overtakes it, and a later year at which the cumulative total received catches up. Both points are often further away than people expect, sometimes well into a second decade. Whether they arrive within your lifetime is the question, and it depends on longevity and on inflation, neither of which is knowable. Quoting a crossover year as if it settled the matter overstates what it tells you.
Fixed escalation as the middle option
Many insurers also offer an annuity that rises by a fixed percentage each year rather than tracking an index. That gives a predictable increase and a starting income between level and index linked, and it removes the uncertainty about what inflation will do at the cost of not actually tracking it. Whether predictability or genuine linkage matters more depends on how much of your essential spending this income has to cover, which is a question about your household rather than about the product.
Who this trade suits
Broadly, it favours people who expect a long retirement, who have little other inflation protected income, and whose essential costs depend on this annuity. It suits less well those with substantial index linked state or defined benefit income already, for whom the level option may leave more spendable money in the years they are most active. This site does not make that assessment for you; a personal recommendation is a regulated activity, and the enquiry goes to an authorised firm.
Questions people ask about index linked annuity rates
How much lower does an index linked annuity start?
Materially lower than a level annuity from the same pot, usually by a large proportion rather than a small margin, because the insurer must fund every future increase from the same capital. The exact reduction depends on the index used, any cap, and age at purchase.
When does an index linked annuity overtake a level one?
There is a year when the annual income overtakes and a later year when the cumulative total does, and both are often further out than expected. Whether they arrive in your lifetime depends on longevity and on inflation, so the crossover year is informative rather than decisive.
What is a fixed escalation annuity?
One that rises by a set percentage each year instead of tracking an index. It gives a predictable increase and a starting income between level and index linked, trading genuine inflation linkage for certainty about the size of the rises.
Who is inflation protection most important for?
Generally people expecting a long retirement who have little other inflation protected income and whose essential spending depends on this annuity. Where a state pension or defined benefit income already rises, the case is weaker and the level option leaves more spendable income early on.