More retirees are buying inflation-protected annuities. What are they and how do they work?

Stubbornly higher inflation has triggered more retirees to buy annuities where the income they get increases each year in line with consumer prices – as well as products that pay out more if you are sick.

With the annual inflation rate at 3.8% for both July and August 2025, the Consumer Prices Index (CPI) is currently high, matching the highest rate since January 2024. While lower than the peak in October 2022, it is still significantly above the Bank of England's 2% target.

Pensioners are increasingly looking for ways to protect the value of their pension income in the face of higher prices. Purchases of so-called ‘escalating’ annuities – which provide a guaranteed income for life and have some inflation protection – accounted for a fifth of all sales in 2024/25 and have increased by 17% year-on-year, according to Financial Conduct Authority (FCA) data.

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Stephen Lowe, group communications director at retirement specialist Just Group, which analysed the FCA figures, said they were evidence of better-informed decision making by retirees.

“The shockwaves of the inflation spike following the pandemic may be influencing customers’ decisions when purchasing guaranteed income for life, with a notable uptick in escalating plans being purchased,” he said.

“But it’s important customers think carefully about the type of annuity they purchase – once the decision has been made it can’t be undone,” Lowe added.

We look at whether now is a good time to buy an annuity in a separate article.

What is an escalating annuity?

Escalating or inflation-linked annuities provide a retirement income that increases each year, either by a fixed percentage or in line with an inflation index like the Retail Price Index (RPI), a common measure of how the cost of goods and services changes each year. RPI was 4.6% in August.

This type of annuity starts with a lower initial payment than a level (fixed) annuity but aims to preserve the real value of your income over time by combating the effects of inflation, though it may take many years to match the income of a level annuity.

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).

The main benefit is that your retirement income won't lose its purchasing power due to inflation. But you have to weigh up whether you can afford the lower initial payment for a period until the increases catch up.

Before choosing either an inflation-linked annuity or a level annuity it is a good idea to get financial advice to understand which type of annuity, and which level of increase, is best for your personal circumstances. Because once you’ve bought an annuity, the decision can’t be reversed.

Enhanced annuity sales rising

Sales of enhanced annuities are also on the rise, as retirees with health conditions seek out ways to increase their income against a backdrop of rising prices.

An enhanced annuity – also known as an ‘impaired annuity’ – pays a higher guaranteed income than a standard annuity because it assumes a reduced life expectancy due to health conditions or lifestyle factors like smoking or obesity.

Enhanced annuity sales increased as a proportion of total guaranteed income for life sales, and now account for nearly half (48%) in 2024/25 compared to 38% six years ago, according to the FCA data.

How do you qualify for an enhanced annuity?

To qualify for an enhanced annuity you typically complete a health questionnaire, and a medical report from your doctor may be required to confirm conditions such as diabetes, heart problems, or neurological conditions.

While insurance products usually become more expensive with health issues, annuities are the opposite: a poorer health prognosis can lead to a more favourable income for life.

Lowe said: “Our own analysis suggests around two-thirds of guaranteed income for life customers could be eligible for enhanced rates so we are slowly nudging towards a situation where the majority of customers are benefiting from the best rate available to them.”

He recommended all retirees take the free, independent and impartial guidance from the government-backed Pension Wise service before making any decision to buy an annuity.

“Professional annuity brokers or financial advisers can help customers choose options and compare between providers to secure the most suitable product and best rate,” he added.