Despite the fall in the annual CPI inflation rate to 2.2%, inflation remains a key risk for retirees as their income in retirement is typically fixed.
More than 90% of consumers purchase level incomes when they retire, which means their real spending power over time is reduced even if inflation is only growing slowly.
Take for example a man-aged 65 with a £50,000 pension pot1. The average income from a level single life annuity, with a 10-year guarantee, is £2,668 a year. If the rate of inflation for the 20 years of retirement is the same as it has been for the 20 years up to 2012, by the time this man reaches age 85 his income in real terms will only be £1,500, a reduction of 44%.
So what are the options available retirees to help combat inflation?
One option is an escalating annuity, which offers a lower starting income than a standard annuity, an average rate1 which increases at 5% a year starts at £1,349, around half the level annuity. Over time the income from the escalating annuity catches up with the standard annuity, but it takes till age 91 for the cumulative income paid out by the annuity to beat the income from a standard level annuity.
Another option is to maintain some investment exposure during retirement, as a hedge against inflation to hopefully maintain income in real terms through retirement. This can be achieved using income drawdown or an investment linked annuity.
Andrew Tully, pensions technical director, MGM Advantage commented: "We need to rethink retirement as income needs to stretch across a 20 to 30 year time horizon. Inflation can have a devastating effect on fixed incomes, so considering some exposure to investments should be part of the decision making process.
"Continuing investment exposure in retirement clearly comes with some risk. If investments perform poorly income may fall. But for those willing to accept this risk it can provide a valuable option to beat the corrosive impact of inflation while allowing a higher and more flexible income than an escalating annuity.
"People don't need to only use one retirement income option. A blend of two or more products may help provide a high guaranteed income but with some scope for investment growth to offset the impact of inflation."
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