There are many important issues for those approaching retirement, including how to protect their pension inc-ome from the effects of inflation.
This issue has raised its ugly head again as the UK inflation rate rose to 3.5 per cent in January from 2.9 per cent the month before and this is the steepest annual rise for 14 months.
At retirement, most people are attracted to a level annuity rather than one linked to the retail prices index because the starting income is some 40 per cent higher and it would take over 17 years for the RPI annuity to reach the level annuity.
Just because an RPI annuity is very expensive, it does not follow that investors should shun them or avoided protecting their pension income from the effects of inflation, especially when the spending power of a level annuity is halved in just over 20 years if inflation was to average 3.5 per cent. The average 60-year-old may live for another 25 years.
In fact, a big part of middle Britain may be making the mistake of buying level annuities because they are basing the decision on short-term factors such as the starting income rather than considering longterm factors such as their longevity, future income needs and threat of inflation.
One way of hedging against inflation is to consider an assetbacked annuity. These include Prudential’s with-profits annuities, MGM’s new flexible income annuity and Lincoln’s i2live annuity. The rationale is that in the longer term, equities will provide an effective hedge and the annuity income will increase if investment returns are above a certain level. Clearly, these annuities are more risky than level annuities and therefore only suitable for those who can take this risk.
Billy Burrows Director The Retirement Partnership
Perhaps those facing difficult decisions over their annuity options can learn from the world of investments, where the cardinal rule is don’t put all of your eggs in the same basket. Translated into annuities, this might mean investing part in a level annuity for maximum growth, part in an RPI annuity for guaranteed inflation protection and part in an asset-backed annuity for future income growth.
This does not have to be complicated because a specialist annuity adviser should be able to arrange a portfolio of annuity options by arranging annuities from different insurance companies. This portfolio might include guaranteed annuities or fixedterm annuities as well assetbacked annuities.
The governor of the Bank of England might be getting ready to write a letter to the Chancellor explaining why inflation is soaring ahead and this should prompt professional advisers to explain to their clients the various ways of protecting their annuity from the future effects of inflation.
Learn from the world of invest-ments, where the cardinal rule is don’t put all of your eggs in the same basket