HomeBusinessPensions hit by inflation: Retirees face huge losses in spending power

Pensions hit by inflation: Retirees face huge losses in spending power


Pensioners who paid a premium for protection against inflation are still thousands of pounds down, despite soaring prices.

Retirees are facing huge losses in spending power as inflation — which is tipped to surge to above 8 per cent this year — eats away at the value of their income.

The state pension will increase by just 3.1 per cent in April — the same month that inflation is predicted to peak as energy bills are hiked by more than 50 per cent.

Undermined: State pension pay increases annually, but retirees are still facing a real-term loss in income of 2.4% this year

Putin’s war in Ukraine is also now driving up the prices of oil and gas.

But analysis for Money Mail reveals that those who paid extra to guarantee that their private pension rises in line with living costs have still not made their money back.

Is a protected policy worth the cost? 

Today, there are more than six million annuities paying pension income to retirees, according to trade body the Association of British Insurers (ABI) — and the latest figures show that around one in seven of those sold rise in line with inflation.

But inflation-proofing an annuity typically costs twice the price.

A 65-year-old retiree with a spouse aged 60 can today expect to receive a flat annual income of £4,141 in exchange for £100,000.

Yet the same pot would buy an inflation-linked annuity that initially pays just £2,148.

Analysis from the Retirement Planning Project shows that a joint life annuity bought more than ten years ago with a £100,000 pot will so far have paid out £57,475 in annual fixed payments of £5,225.

Yet an annuity guaranteed to rise in line with the Retail Prices Index (RPI) measure of inflation will have paid out just £35,649.

The annual income will have started at £2,851 and risen to £3,783.

William Burrows, founder of the Retirement Planning Project, says: ‘You pay through the nose for inflation protection.

‘An inflation-linked annuity really is the preserve of the high net worth people who can afford it.’

But he adds: ‘It’s a high price to pay.’

Mr Burrows says that for most retirees the state pension provides enough inflation proofing, and for them, buying a level annuity with their own money might be a sensible option.

Fixed-rate deals give a head start 

The Bank of England aims to contain annual inflation at an average of no more than 2 per cent.

But analysis from investment broker Hargreaves Lansdown reveals that if inflation rose at that rate, it would take nearly 30 years for an inflation-linked single annuity to pay the same income that a fixed-rate deal did on day one.

Over those 29 years, the level annuity would have paid out £156,000, and the inflation-proofed product just £124,057.

The state pension will increase by just 3.1% in April — the same month that inflation is predicted to peak as energy bills are hiked by more than 50%

The state pension will increase by just 3.1% in April — the same month that inflation is predicted to peak as energy bills are hiked by more than 50%

Life expectancy figures suggest the average retirement lasts between 20 and 25 years for a man aged 65.

If annual inflation remained steady at 3 per cent, it would take 20 years for the inflation-linked annuity to pay the same rate, and 12 years if inflation stayed at 5 per cent.

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, says the figures showed inflation-linking is not always worth the price.

She says: ‘Even though the 5 per cent index-linked annuity would start to deliver more income after 12 years, it would take many more years before the total amount you got from the annuity would outstrip that of a level annuity.

‘For someone annuitizing at 65, they would probably be in their mid to late 80s before they would get to that point.

‘If inflation stayed at 2 per cent, for instance, it would be difficult to justify on that basis.’

She says retirees did not have to buy an annuity with their entire pension pot all at once, and adds: ‘This can enable you to benefit from rising rates or enhanced annuities at a later point that will give you a higher starting income.’

Hetty Hughes, policy manager for long-term savings at the ABI, says it is essential to get financial advice or guidance from services such as Pension Wise.

She says: ‘There is no one-size-fits-all approach when it comes to deciding which pension products are best for retirement.’

State pensioners are losing out

State pension pay increases annually, but retirees are still facing a real-term loss in income of 2.4 per cent this year.

It comes after ministers abandoned the triple-lock pledge to increase payments in line with the highest of either inflation, wage growth or 2.5 per cent.

The move was made after earnings spiked by 8.8 per cent in the pandemic.

Rishi Sunak has frozen the pension lifetime allowance for five years - leaving savers liable to pay more tax as their pot grows

Rishi Sunak has frozen the pension lifetime allowance for five years – leaving savers liable to pay more tax as their pot grows

Instead, the nation’s 12.5 million pensioners will receive pay rises linked to September’s inflation rate of 3.1 per cent, even though the Consumer Prices Index (CPI) measure is now running at 5.5 per cent.

It means that the new state pension will be worth £185.15 a week from April. In real terms, this means a pay cut of £4.30 a week, or £223.60 a year.

Those collecting the old state pension will receive £141.85 a week — a real-terms pay cut of £3.30 a week, or £171.60 a year.

The gap between prices and pension pay will grow further if inflation hits 7.25 per cent, as the Bank of England has predicted.

Jon Greer, head of retirement policy at wealth manager Quilter, says: ‘For those retirees who rely solely on the state pension, this kind of reduction in the real value of their payments will hit them hard, especially against a backdrop of rising food and energy prices.

‘While this could prove to be a difficult year for many pensioners, there should at least be light at the end of the tunnel next year when the next state pension increase is based on the inflation that we are experiencing.’

Generous public sector salary-linked pensions rise with September’s CPI rate of inflation every year.

Yet some private sector schemes will cap increases at 5 per cent for RPI or 2.5 per cent for CPI.

Some pension schemes that have collapsed and been saved by the Pension Protection Fund are also capped at 2.5 per cent.

Savers facing the big freeze

Chancellor Rishi Sunak has frozen the pension lifetime allowance for five years — leaving savers liable to pay more tax as their pot grows.

The £1.07 million allowance dictates how big a pension pot can be before savers have to pay tax on contributions.

Workers face an extra tax bill on savings over that limit, as well as the usual income tax on the cash that comes out.

Analysis by broker AJ Bell reveals that if inflation rose at 4 per cent over the five-year freeze, the lifetime allowance should grow to £1.62 million in order to keep up.

Yet the freeze means that retirees with pension pots over this amount will face charges on an extra £189,100.

If this was taken as a lump sum it would be taxed at 55 per cent — costing the savers £104,005. If it was taken as income, it would be taxed at 25 per cent, which would cost the retiree £47,275.

Tom Selby, head of retirement policy at AJ Bell, says: ‘We will inevitably see the lifetime allowance becoming a factor for swathes of middle Britain who do the right thing and save diligently for their future.’

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