Dealing With Inflation In Retirement

Retirement and inflation are words that, generally, don't sound good together.

Generally, inflation favours borrowers and punishes savers - and most retired people fall squarely into the latter category. There is some good news, such as the "triple lock" that guarantees that the state pension will increase annually, either by the rise in earnings or prices or by 2.5%, whichever is greater. A long time ago, this pension was linked to earnings which were then rising faster than prices. Then it was disconnected from earnings and linked to prices and as earnings have pulled ahead of prices, pensioners have lost out. The triple lock has re-established this link and put on the lock so that state pensions rise faster than has recently been the case.

Some who may come out of inflation on the right side are the lucky few with fully index-linked public sector pensions such as those in the civil service, teachers and the NHS. Their pensions are fairly well insulated - at present they go up by the level of RPI and though it is proposed to change this to CPI, without a ceiling on increases these pensions are well placed. Another group who are protected to some extent from the effects of inflation are those with private sector final salary schemes where part of the pension goes up by inflation. These are the lucky people, but for those who think they have got their planning right and have retired without debt but with savings, inflation is their mortal enemy.

Inflation-proof private annuities are available to those who have bought or are buying a private annuity with their own pension funds. However, the downside here is that the starting level of an inflation-linked pension is significantly less, possibly up to 40%, than that of a level pension. This shortfall is two-fold - initially income has to increase to where it would have been if you had bought a level pension however even then you remain behind the game because for all that time you have had less money. Therefore it has to rise by the same amount again before you have more money in your hand. If inflation stays modest this can take 14 or 15 years, though if inflation goes mad the payback period is much shorter.

My experience is that most people decide they want the income now and I think I would do the same - psychologically, we value money now more than money in the future. In fact this is logical because as people get older they tend to spend less - unless they need care, in this case their outgoings will rise considerably, however this is something that can be planned for elsewhere. The best combination, if you can do it, is take a level pension and save some of the income to build up a buffer fund for the future - although this isn't that easy as most people tend to spend up to their income.

Another alternative, generally for those with bigger financial pots, is an unsecured pension which involves investing the money and drawing income year to year, rather then buying an annuity. Contrary to received wisdom, I don't think this is likely to produce a higher income over time, even though this is given as one of the reasons for doing it. You have to take into account the costs of running the scheme, financial advice and mortality cross subsidy - something insurance companies factor into annuities so that the figure reflects the fact that some holders will die before their average life expectancy and some will live beyond it. If your investment is in your own pot, then you don't get that. This combination deletes some of the advantages although you still have to consider the imponderables of investment performance. Unsecured pensions can be beneficial although I don't agree that getting more money out in the long term is a benefit.

However, money is not going to earn anything left in the bank. Keep an emergency fund, but to counter inflation look at investing the rest. Older people tend to be less risk tolerant than younger people which is quite logical as, if you lose money when you are older you don't have so much time to get it back as you do at 25!

But there is risk and risk. My view is that you ought to have an asset mix that's pretty cautious but at least gives you fighting chance of maintaining the purchasing power of your money. You can be at the cautious end but you have to take the step up from savings to investments. You should also take full advantage of the ISA allowance of £10,200 per person. This means a married couple can tax shelter over £20,000 a year, which is not to be sniffed at.

Retired people have to take every advantage and really need to take that step up to have a fighting chance in inflationary times.

Comments? Questions? Email Here

© HowtoAdvice.com

How to Advice .com