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conventional annuity
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The most common type of annuity, a Conventional Annuity guarantees at the outset how much income (before tax) you will get from year-to-year. This allows you to easily budget your outgoings against your income.
Advantages
It provides a known and secure level of income for the rest of your life.
It provides an income for life - an insurance against living too long and outliving your means. You can choose for your income (before tax) to increase at a fixed rate and help offset the impact of inflation.
Disadvantages
Its buying power may not keep pace with inflation, even if you choose an increasing income
The higher the increase you choose, the lower your starting income.
You're locked in at today's interest rates for the rest of your life (annuity rates go up and down with interest rates, although this could be an advantage when annuity rates are high).
How it works in more detail
Income from a Conventional Annuity can either continue as a level payment or go up by a fixed amount each year:
What does a level payment mean?
The basic annuity you can arrange is one that will pay you the same amount of income every year throughout your retirement. It never goes down and it never goes up.
At first this may sound like a good idea, and certainly a level annuity will often give you the highest starting income of any of the retirement income products. But what about coping with increasing prices? With inflation, the purchasing power of your income will forever be decreasing.
For example; even if inflation were to run at 2.5% for the rest of your life, the purchasing power of your income would be reduced by 25% after 12 years.
What does an increase in payment mean?
There are steps you can take to protect your income at least partially from inflation. You can choose to have
guaranteed increases (also known as 'escalation') built into your annuity each year, although this will mean a reduction in your starting income.
Depending on the type of pension you have now, you may be able to choose any increase from 0.1% up to 8.5% a year (subject to HM Revenue & Customs (previously known as Inland Revenue) restrictions). This increase is guaranteed throughout your retirement. It will never fall. But the higher the rate of increase you choose when you buy your annuity, the more your initial income will be reduced. Although your chosen rate of increase may not protect you fully from the effects of inflation, you'll have
better protection than if you had no increase at all.
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