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Time to face facts about inflation and your retirement

How to prepare for a happy retirement free from the the worries of inflation. Save a very large sum of money.

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by Lorna Bourke on May 11, 2011 at 18:12

Inflation is an insidious invader which eats away at our spending power – and nobody suffers more than those in retirement. Unless they are still working most pensioners have no means of making good the shortfall as the cost of living rises.

Latest figures from charity Age UK highlight just how bad the situation is becoming. Since 2008, over 55s have faced additional costs of £918 a year due to inflation. And the older you are, the higher the extra costs. An average 65-69 year old faces additional costs each year of £1,054 since 2008. In the past three months alone the cost of living for older people has risen by between 1.35% and 1.58%.

‘Those in later life have consistently experienced price rises at a higher rate than the general population or predicted by official measures,’ said Gordon Morris, managing director of Age UK Enterprises. 'At an age when a significant number of long-term financial decisions are being made, being able to accurately track the cost rises experienced by those over 55 is crucial.’

To make matters worse, those in retirement are suffering low interest rates on their savings and generally derive no benefit from lower mortgage repayments. Higher petrol costs hit older drivers hard as many pensioners retire to the country where a car becomes a necessity.

Facing up to reality

‘When people plan for retirement, they need to form a view on how much money they will need to get by from one year to the next,’ said Erik Britton from Fathom Consulting. ‘In order to do this accurately, it is important that they have access to reliable information on changes to the cost of living for people in their own age group, rather than the population as a whole.’

The solution is, of course, an index-linked retirement income. Many in the public sector will receive an inflation-proof pension from their employer. But as final salary schemes in the private sector gradually disappear it is up to individuals to provide their own inflation proofing – either by means of an index-linked annuity or by drawdown from a pension fund which remains invested – and hopefully manages to show a return on the investments in line with inflation or more.

Annuity rates low

To make matters worse annuity rates have fallen in recent years as a result of lower investment returns and increased longevity. ‘On the whole, annuity rates remained static this month,’ said Gemma Goodman of Alexander Forbes Annuity Bureau. ‘However, this means that the impact of rising inflation is even more pronounced. With a current RPI (retail prices index) inflation rate of 5.3%, the purchasing value of a level annuity is potentially halving every ten years.'

Providing your own index-linked annuity, which is the only safe way to counter the effects of inflation, is expensive – approximately double the cost of a level annuity. For example for £100,000 a 60-year-old male can buy a level income for life of £6,190 a year or a female of the same age £5,860. But if the £100,000 is used to purchase an inflation proof annuity linked to increases in the RPI the income falls to £3,610 for a man or £3,300 for a woman. Similarly if a couple purchases a joint life annuity (male aged 60 female aged 57) for £100,000, the level income is £5,670 a year but if you want inflation proofing the income falls to £3,190.

These are ‘best buy’ rates from broker Alexander Forbes and other providers may well pay substantially less so it definitely pays to shop around if you are looking for a lifetime income from an annuity whether payments are level or index linked.

How much do you need?

So how much do you need to save to buy a reasonably comfortable index-linked retirement income? According to the OECD we should aim for a pension of 70% of the average pre-retirement income of £31,500 – or around £22,000 a year. An individual with no company pension would therefore need to save around £355,500 to provide a level income of £22,000 at age 60. But to inflation proof the income you would need £610,000.

This is a daunting prospect, enough to put many off saving altogether. So how do people react? ‘Early education to impress on people the gravity of the situation and the size of funds that are required is important,’ says Keith Churchouse of Churchouse Financial Planning which specialises in retirement planning. ‘The first thing we do is look at what state pension a person can expect, what company pension they might be entitled to and any other assets they may have. But some are still sadly relying on the equity in their property as their retirement fund.’

He says, ‘the reality is that many are scared by the figures. But if they can start to save a proportion of the capital needed, they can revisit the situation at a later date or maybe they will have to adjust their expectations downwards. Many do take the situation seriously and discuss things with their family. Some still just walk away.’

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18 comments so far. Why not have your say?

Having had to 'retire' at just the wrong time, my wife and I have fixed rate annuities that singularly lacked their potential before UK went into debt, and the stock market crashed. The result is that we have to continue working and earning, come what may. Thsi perspective is not addressed by any sector of goverbnment or financial planning support. How about some good advice for those who have been well and truly stuffed by UK Government!

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It is time to bring back compulsory for retirement it is no longer acceptable to presume the Government is going to take care of you in old age. The reality of the situation has not dawn and people need to accept that they have got to save. The Government should incentivise savers with tax breaks raise the ISA saving level and bring it up to days value. I have retired early but going back to part time work shortly and will use the additional income to increase savings. Yes I do have a pension albeit a small one and have yet to get the state pension. The good old days have gone lets wake up to reality.

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I have been paying into a private pension for quite a long time now and feel i had done the right thing, but now i am not so sure the government have kept moving the goal post with great frequency and Gordon (Prudence) Brown seems to have escalated the situation, so now i don't feel inclined to add to my funds. I have never been a big earner and my maximum wage before i lost my job was 25k less tax.

My mind set is that i am screwed if i do and screwed if i don't keep contributing, the whole situation seems a mess.

I am also sickened by the fact that PMs have one of the best pension set ups in the UK Cast iron and ring fenced and great money !!

I am sure by the time i retire in ten years time the stock market will have bombed out !! annuity rates will be down to nothing and due to inflation my pension will be able to buy me a bottle of milk so thanks to all those politicians both labour and conservative who have done a bigger hatchet job on pensions than Bob Maxwell. At least he had the decency to top him self the politicians don't have the guts for it, but are fantastic with the pen on the expenses forms. Yours truly Very P- - t off.

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Why do I feel a vested interest from Financial Planners? Long term slow savings into a pension plan just gives the financial institutions longer to rip you off with no guarantees from their side.

Keep your money safe (or as safe as you can) and pay off your debts (including any mortgage) as quickly as possible. Only when you don't have a mortgage or any other financial commitments (children for example) should you contribute to a pension. Then you will know what your needs are and be nearer to retirement so understand what rules will apply - what dates you will be able to draw on your pension, when (or if) you will have to buy an annuity, etc..

Don't plan for anything over a time horizon of longer than the next parliament because the only guarantee is that the next lot will change the rules and whatever you've planned will be wrong.

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If people could save the shortfall of £4.4 to £9 trillion pounds would it distort the markets? Cash savings would push or keep interest rates down and would buying shares or similar products not create a new price bubble?

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Great input Mark22 and the way I'm playing the game though currently I do worry a bit about 2nd guessing the way the current or next lot are going to change the rules e.g. if higher rate relief is removed I may kisk myself I didn't pump money in sooner.

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I'm in a more fortunate position than most - coming up to retirement with a total pot of pensions, ISAs, SIPPs etc etc of c £1m.... BUT I am going to live a LONG time (geness)... my problem is simple - how do I protect the pot from inflation AND take a 3% index-linked annual income ?

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Well we are back to low interest rates I guess, with the connivance of the bankers and the politicians, to rescue some of the banks from writing down their debt and in some cases going bankrupt.

Whilst we allow the market to be interfered with this nightmare of artificial interest rates and rising inflation will remain.

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It used to be that the national insurance was to pay for healthcare and pension but succesive governments have used the money for their own pet projects.

I agree entirely with mark 22 and understand michael turners position, but as I have said before the pension sytems in britain are acomplete shambles unless you are in the public sector.

I nflation can easily destroy alife work of prudence and thrift.

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@DGL - 3% index linked isn't too hard and even an annuity can pay that. Alternatively go for a basket of high yielding Investment Trusts, OEICs (expensive!) or just buy good value but high yielding shares yourself. Note that dividend income is taxed at 10% before you get it and there is no further tax for basic rate tax payers, which makes it very attractive compared to other investments. My plan is to pull out max PCLS, do max drawdown from my pension while still keeping within basic rate, and invest all free money into dividend income assets in my wife's name. Of course, you should leave your ISAs alone as long as possible, and even keep using CGT allowances to "Bed and ISA" to both keep CGT under control and make life easier at tax return time.

I don't intend to rely on either HMG or pensions companies any more than is necessary.

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Yes, it would be good to save a bit more for retirement, but the level of taxation is so high no chance...... so will join the rest and let the Govnerment look after me......

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I use the (increasingly) high taxation levels as an incentive to put more into my pension as I can do it gross of tax (20%, 40%, 60%, 50% - pick your number!) and employees NI (2%) as my employer does salary sacrifice. They also put some extra in to make up for this saving them 13.8% employer's NI.

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sgjhaghsdg

Thanks - However I need my pot to grow with inflation AND give me a 3% index-linked income..yet minimum risk !!

Even tho' about to retire - facing the problem of probably living another 30 years !

Terrified about another bout of inflation like 70s and early 80s !

Of course, I've got dozens of IFSa , wealth managers etc claiming they can sort me out...

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DGL - Take a long hard look at some of the Investment Trusts as described by Monevator here - http://monevator.com/2010/05/26/investment-income-trust/

Also maybe wander along to the Motley Fool boards, particularly the Investment Trusts one.

They are less risky than individual stocks and less work. But if you only want 3%, then what's wrong with an annuity? Even at 55, you should be able to get 3.6% escalating income.

As for IFAs, your pot is large enough to justify getting some advice, but maybe work on paying a fixed fee rather than a percentage and make sure the adviser isn't getting ongoing commission at your expense.

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The problem is most articles on the subject are written by those with heavily vested interests and most legislation passed is done with the approval of the fund management industry who need you to be forced to contribute to funds with heavy rates of fee extraction over the long term.

Annuities are probably the worst choice you could ever make ( and that is why many are forced to buy them ) for example take the annuity rate of 5500 quid odd quoted above, the purchaser bears the risk of the pension/annuity provider going bust and is paid nothing for it and actually gets a worse rate given all the fees and charges built into it, a perpetual government gilt such as the consols will pay currently a 5% or 5000 quid annuity forever, when you die your kids can enjoy the income, or when you are very old you can sell it and get your money back for whatever treatment you need. If you are prepared to take insurance company risk you can buy an Aviva perp which will yield you 7.7% at the moment which is 2% higher than their annuity, and you keep it when you die, why are these strategies never highlighted ? because there is no commission in it for the IFA ........

The pensions management and fund management industry make a killing out of forced savings and the investor is often forced to bear the risk of them going bust for no return on top of huge fees which in the long term decimate even good market performance.

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I'm still learning investment jargon: is a perp an irredeemable preference share? If so, I have a few. I've spread the risk (a little!) by mixing insurers and banks, and as both are out of favour, have yields in excess of 8%. I intend to enjoy the dividends until the big guys are once again happy to hold these, which will lower the yield, and I will then take the capital gain.

Of course, it could all go wrong, and despite the "irredeemable" in the title, they have at times been called at face value.

BTW, when looking at these 5% and 7% figures, remember this is flat rather than rising with CPI/RPI, and the 3.6% annuity figure I quoted was an escalating figure. However, I still reckon that a good mix of investments can get you a similar figure, that (probably) rises faster year on year, and doesn't involve a 100% loss when you kick the bucket.

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I have never assumed that the government would look after me in retirement...although they have consistently 'stolen' too much money in the form of NICs and tax.

Financially, the only way is to look after yourself, which would be a lot easier if the tax system were not so draconian.

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sgjhaghsdg

May 13, 2011 at 22:06

If the money I had paid in NICs (employees and employers) had all gone into my pension, I'd have as fat a pension pot as those public sector peeps. Sadly, it all seems to have gone into their pension pots . Oh well.

In my pension projection spreadsheet, I show more being taken in tax than I get in state pension. Remind me, why do I pay tax and NI/?

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