Last month’s inflation rate of 3 per cent will be bad news for most but those over state pension age may be less glum. The September figure is considered for the annual up-rating of state pensions, and with inflation higher than earnings increases and the 2.5 per cent underpin of the triple-lock, it should see a boost of just under £4.80 a week.
This lifts the new state pension to around £8,570 a year. An inflation-linked annuity for that amount for a 65-year-old today would cost just over £266,000. The benefit of the triple-lock, for as long as it lasts, makes the cost of fully replicating the state pension using an annuity even higher.
Given its value, do we make enough of it as part of retirement strategies? The opportunity to top up state pension closed earlier this year but there is still scope for people to close gaps in their National Insurance record to make sure they are getting the maximum entitlement. Given the cost of replacing that income in the market, it seems a no brainer.
But what about state pension deferral? Many advisers are sceptical of this and clients will be reluctant to not claim something they have contributed all their life for. Following the changes to the terms of deferral for those retiring after 5 April 2016, these challenges may be even more justified. But if we consider this option as an alternative to buying an inflation-linked annuity it makes sense. In fact, it could deliver nearly 50 per cent more income.
We looked at somebody with £50,000 to commit to guaranteed income and compared how much they would get in additional income from deferring their state pension and living off the £50,000 until it ran out versus buying an inflation-linked annuity.
If I bought an inflation-linked annuity, I would get only £1,600 or so of additional income. This would mean I would have a starting income of around £10,170 once added to my state pension. Deferring state pension, I could take a starting income of just under £11,000 from the fund until it ran out, which would take just under five years.
This is around £2,400 above the new state pension, an increase of 28 per cent on the state pension and 50 per cent more than the annuity. Once the fund is exhausted, my state pension starts at a level 28 per cent higher than it would otherwise have been.
But what if the client dies before the higher state pension pays back the missed payments? It is a risk but the same applies to an annuity. Remember too the deferred state pension can be taken as a lump sum so if a health concern emerged during deferment this could provide a useful escape route.
This analysis does not factor in tax. If taking my state pension now means I pay a higher rate of tax than I would if I deferred it a few years, then again the numbers look convincing.
Of course, people want what is rightfully theirs but do not let that get in the way of sound financial planning.
Richard Parkin is head of pensions policy at Fidelity International