Inflation - who cares?
Retirement, pensions and inflation.
Pensions freedom is the phrase on everyone's lips. Barely a day goes by when someone doesn't ask me about it or mention it in passing. Newly liberated from the shackles of compulsory annuitisation,many of us are in danger of behaving like metaphorical rabbits, sitting in the middle of the road, mesmerised by onrushing headlights and forgetting all manner of important things like the need to get out of the way!
One way or another, pensions freedom means that we will have to keep more than a weather eye on investments and investment strategy in future. No longer can we simply choose to forget about the investments underpinning our pension. The luxury of buying an annuity and watching the money come in while we toy with the 25% tax free cash, has gone. In future, we will all have to concentrate on investment strategy, risk, return and all manner of variables, and not least among these is inflation.
Inflation...with the Consumer Prices Index (CPI) suggesting that living costs are barely moving in many parts of the developed world and with negative inflation in the UK, many investors are beginning to wonder whether protecting their savings from inflation is even worth the bother.
The policies of Quantitative Easing and record low interest rates were supposed to stoke the fires of inflation but despite the enormous amounts of money allocated to the strategy thus far, the nascent global economic recovery has yet to had much (upward) impact on prices.
So why worry? Moving slightly to one side of the official, Government, pronouncements there is an area of concern that relates specifically to the retired population.Identified some years ago by Age UK is the fact that, as we age, so our spending habits change.
In our early adult life we tend to spend most of our disposable income on televisions, holidays, games, toys and hobbies, cameras, clothes, alcohol etc and according to the Office for National Statistics these are all areas which have benefitted most from deflation. TVs, cameras and computers for example have fallen in price by 61% in the last decade, with clothing and footwear, games and hobbies benefitting from 19% and 18% falls respectively.
Source: Office for National Statistics
On the other hand, the last ten years has been witness to an increase in electricity costs of 105%, a 34% hike in health costs with food and drink jumping by 42%. These are all core expense areas for the retired and as we get older, they start to make up more and more of our expenditure. Research by Age UK found that 'since January 2008, Silver RPI has averaged 4.6% a year'.
Age UK call this phenomenon 'Silver Inflation' although less prosaically, Actuarial Post call it 'Pensioner Inflation'. Whatever you call it, the bald facts are quite startling; if you retire on a fixed income, inflation will cut your spending power by 60%. Put another way, if you retire on a fixed annual income of £16,000, after twenty years the real value of your income will have fallen to £6,720. (Source: Actuarial Post)
If you relate this to the new Flexible Access Drawdown environment it suggests that ignoring inflation could become even more risky.
Taking a simple example. Assume you retire at age 65 with a fund of £100,000 and you have no need to preserve the fund for a spouse or beneficiaries. Taking a fixed annual income of £5,000 means that you can adopt a moderately cautious approach to investing and reasonably expect your income to last for the rest of your life.
Using the same example but taking the average Silver Inflation rate (4.8%) as a basis for index linking your income, the fund will be completely eroded by age 75. Statistically, you will have an 81.58% probability of surviving to age 75 (source: Prudential) and there is a 50:50 chance you will be alive ten years hence.
Logically, you can deduce that to maintain your spending power, either you need a larger fund at retirement, to take less income, accept a greater investment risk or simply acknowledge that as you get older your income will inexorably decline in value.
From an advisory perspective, it suggests very strongly, that the need for advice (not 'Guidance') is more important than ever. Retirement planning was always a little complex, but it has just got a lot more involved.