Hedging Retirement Income Against Inflation

As inflation in Britain and across Europe ticks up and the Pound weakens, expats on flat retirement incomes can see their spending power dropping away.

Although the changes are small and largely accounted for by higher air fares and paying more at the pumps for fuel, more increases in the cost of living are on the way.

Financial experts are warning retirement savers that after a year or more of near-zero inflation, failing to consider how price rises impact on income can easily throw a budget out.

The big decision for those approaching retirement is whether to buy an annuity, and if so whether to index link the income.

The problem is the cost.

The cost of inflation proofing income

Buying a flat guaranteed income for life of £10,000 costs a 65-year-old man on standard rates £190,000.

Adding a 3% year cost of living uplift raises the annuity purchase price to £270,000.

“Since the introduction of the pension freedoms people have increasingly been opting for drawdown over annuities. Drawdown allows people to keep their savings invested in the market and take an income,” said Kate Smith, head of pensions at Aegon.

“This approach is often said to offer some protection against inflation as shares tend rise in line with inflation, but the downside is that retirees have to contend with investment volatility and may need to reduce their income if the value of their investments falls.

“These trade-offs between income certainty and investment volatility are all part of the new retirement landscape so it’s important that people take time to consider their options carefully.”

Inflation beating returns

Investment house Hermes points out that despite low inflation, cash worth £100 in 2010 is only worth £16 today.

The firm also believes hedging investments against inflation is both necessary and difficult.

“We group our assets in two pools – one aimed to match inflation while the other targets beating it,” said a Hermes spokesman. “This protects and grows capital. We do not believe beating inflation is enough to generate returns.”

The firm also explained that they use the UK retail price index as a benchmark as risk-adjusted returns are smoother.

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