Inflation - a real blow to pension income. What to do?

When selecting a pension income there are numerous possibilities: full/phased capped/flexible income drawdown; level/rising guaranteed (or not) annuities and many options in between, all of which are offered by dozens of different providers. To say it’s potentially confusing could be an understatement. Sound, independent financial advice can help ensure that you get the most appropriate retirement income for your needs with the least amount of stress. For example, did you know that shopping around for your annuity could add 20% to your income compared to accepting your existing provider’s annuity¹?

But shopping around isn’t the only important consideration; you also need to consider your current and potential circumstances - and what is important to you. In this respect the effect of inflation is an important concept which can often be hard to fully grasp. For example, during the 1970s inflation averaged 13% p/a which would reduce an annual pension of £10,000 to the equivalent of just £2,500 after ten years!
Obviously, by today’s standards we’d consider this to be ‘high’ inflation (the Bank of England’s target is 2%) but recent figures showed a shock rise, the biggest for over a year, to 2.7%. Inflation of just 4% per annum would reduce the purchasing power of a 65 year old’s pension by nearly a half by the time they reached 75.

What’s more, the government’s measures of inflation are of little relevance to pensioners who tend to experience a considerably higher level due to proportionally higher spending on commodities such as food and fuel. Last year Saga calculated that real inflation for 55-64 year olds and the way they live was in fact 6.6%.

The good news is that you can buy an annuity that grows in value in line with inflation so as to maintain your purchasing power. However, these policies typically mean that you need to accept a lower initial income – often more than a third less² and it can take many years to recoup the difference. You need to consider what factors you deem to be the most important in relation to your future retirement. Choosing your retirement income is a completely personal and individual choice and it can be challenging to know where to start . Speak to a financial adviser if you feel you need guidance to make sure you ask yourself the right questions and, ultimately, make the right choice.

1 According to Money Advice Service (government advice service)

2 Based on Hargreaves Lansdown’s “best buy” rates for 65 y/o male (checked 13/11/2012)