Advisers present the option of an inflation-linked annuity to clients as standard practice. So why don't more people choose to protect their income in retirement? Jenna Towler finds out…
Protecting your retirement income from the scourge of inflation sounds like a great idea, right? But according to a parliamentary study, about 95% of people do not bother with this form of defence when they retire.
Fund manager Schroders is calling on the industry to be more innovative in the retirement space and raise awareness of the impact inflation can have on retirement income.
The firm said it was especially important as the number of defined contribution (DC) pension savers reaching retirement increases.
Head of UK strategic solutions Mark Humphreys said: "The lack of options available for DC members seeking a reasonable level of inflation-protected retirement income highlights the need for the development of new products and solutions designed to see retirees comfortably through their old age."
He warned: "A substantial rise in inflation would mean that DC members who have opted for fixed rather than inflation-linked annuities could see a severe erosion of their retirement benefits."
So why is the option of an inflation-linked annuity not taken up by more clients?
Ashley Clark, a chartered financial planner and director of website NeedAnAdviser, explained that while all advisers highlight the difference between standard and inflation-linked annuities, clients are rarely keen to sign on the dotted line.
He told PA: "Clients are not idiots – even on a typical level annuity of say 5% to 6%pa, clients work out very quickly they must live for circa 20 years to just break even and get their original pension capital back.
"When clients then look at inflation-linked annuity rates, they almost laugh at the break-even point and how long they would need to live just achieve a return of capital let alone profit in these lower inflation times.
"No doubt all advisers explain that retirement is ultimately a gamble on inflation, which we all expect to rise, and life expectancy, and it is down to a client's own attitude towards these risk elements in retirement. Some clients select inflation protection, but most prefer ‘jam today'."
He added that while the average UK saver may not be totally informed, they are certainly not fools when it comes to doing the simple income/life expectancy break-even numbers.
Clark commented: "Until the government makes retirement capital more accessible in the same way as IRAs and 401ks in the US or Australia's superannuation, there will always be a huge savings gap."
Corporate Benefits Consulting chartered financial planner and director Allan Maxwell said: "We are careful to explain why clients should consider the option of an increasing annuity and point out the potential impact of inflation, which can have a substantial effect on a client's standard of living if they enjoy a long retirement.
"Clients are surprised by the reduction in immediate income when choosing this option so are reluctant to take this option, especially when many are facing a substantial fall in their income level on retirement – the result of not having made sufficient savings in the first place."
He added: "Where clients have other sources of income, which will increase in retirement (e.g. the state pension or a defined benefit pension), they often choose to take their DC pot as a non-increasing amount because it only makes up a very small part of their post-retirement income. As DC becomes the main source of post-retirement income, I expect this to change."
Split the difference?
Maxwell said another factor that clients have to consider is how their income requirements are likely to change in retirement.
He explained: "It is quite possible that their requirement for income will fall over time as their ‘discretionary spending' may reduce in future as their lifestyle changes. This highlights the inflexibility of the traditional annuity, which fixes future income irrespective of future needs.
"The key is to build in as much flexibility as possible and perhaps split their purchase between an increasing annuity to cover the basic cost of living but purchase a non-increasing annuity with the balance.
"Even if a client does decide to go for a level annuity we might suggest that they still save into an ISA in the early years in order to build up a surplus to deal with future inflation."
‘Tongue in cheek' retirement advice from Ashley Clark
Pay as much as you can into pensions today for maximum tax relief. Move to Australia, transfer your UK pension to an Aussie Super, drawdown as much capital as you can, spend it until it is gone, defer your UK State pension as no inflation increment anyway, come back to the UK when your pension pot is empty and then claim your full deferred state pension and pension credit, which will then become inflation-linked again.
Latest data shows UK inflation (CPI) grew by 2.7% in September, unchanged from August. This change in inflation leaves UK households collectively needing to find an extra £17.7bn a year to maintain their standard of living enjoyed 12 months ago, according to MGM Advantage.
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