Should you link your annuity to inflation?

A steep rise in the rate of inflation last month could affect those who are deciding what to do with their pension savings.

If you opt for an annuity that pays the same amount of income year after year, you could suffer during a prolonged period of high prices.

But opting for an annuity that rises in line with inflation means accepting a lower income to begin with. 

Here, we look at the pros and cons of these options – and explain how to secure the best annuity deal.

Make your money go further

Find the best deals, avoid scams, and grow your savings with our expert guidance. From only £4.99 a month.

Join Which? Money

Cancel anytime.

How inflation affects retirees 

Inflation, as measured by the Consumer Prices Index (CPI), reached 3.5% in April – a sharp increase from 2.6% in March. This was driven by an increase in household bills.

With retirement potentially lasting a couple of decades or more, you need to prepare for the fact that inflation will eat away at your purchasing power.

Even relatively low inflation levels will put pressure on your budget over time, so it's important to think about how to mitigate this. 

• Find out more: how much will I need to retire?

The cost of inflation-proofing an annuity

Buying an annuity involves swapping your pension savings for a guaranteed regular income that will last for the rest of your life.

The most popular type is a 'level' annuity, where your annual income is fixed and doesn't rise over time. 

This is likely because starting incomes tend to be much higher than for inflation-linked annuities.

A 65-year-old with £100,000 in pension savings can currently get around £7,800 a year from a single-life level annuity. 

But this falls to around £5,700 a year if they want an annuity that rises by 3% each year. 

• Find out more: what are annuities?

If you take out an annuity as a result of using the service from HUB Financial Solutions, Which? will earn a commission to help fund our not-for-profit mission.

Check your annuity options

Which? says you can trust HUB Financial Solutions to compare across the whole market

Find out more

Is it worth protecting your annuity against inflation?

If you opt for an inflation-linked annuity, you’ll start with a much lower income than you'd get with a level annuity, so it will take you many years to catch up.

Calculations by Hargreaves Lansdown show that a 65 year old with an annuity that increases by 3% a year would have to wait until they were 76 to get an income in excess of £7,800 a year (the amount they'd get from a level annuity).

They would then need to wait until they were 85 before the total income from the inflation-linked annuity exceeded that of the level annuity.

If you aren’t confident about your health over the long term, it's worth thinking twice before opting for an inflation-linked annuity.

• Find out more: rates for inflation-linked annuities

Annuity rates on a high

Annuity sales have been boosted in the past few years thanks to the higher rates on offer. 

Providers typically use government bonds (gilts) to fund the income they promise. These low-risk investments pay a fixed rate of interest, which tends to rise and fall with the base rate.

A higher base rate means that gilt yields rise, too – and that pushes annuity rates higher. That’s exactly what we’ve seen over the past couple of years, with rates hitting a 16-year high.

But the Bank of England cut the base rate to 4.25% in May, and further cuts could follow. This could mean lower annuity rates in the future.

• Find out more: best annuity rates 2025

Shop around for the best annuity deal

Once you've bought an annuity, you can't reverse it, so it's important to choose carefully. 

The amount you’ll get from an annuity depends on the size of the pot you’re converting and the rate offered by your chosen provider. 

Many retirees will stick with their existing pension provider when buying an annuity. However, the market is competitive, so accepting the first quote you’re offered could mean you miss out on thousands of pounds over your retirement.

The more information you share with your provider about your health – from whether you smoke to details of any medical conditions – the higher the income you could receive. 

This could be as much as 30% more than a standard annuity. That’s because the provider won’t expect to have to pay out for as long if your life expectancy is shorter than average. 

• Find out more: what are enhanced annuities?