Advice firms should help clients to inflation-proof their annuity, after Hargreaves Lansdown research highlighted the substantial impact the cost of inflation is having upon annuity incomes.
Inflation has been on a rollercoaster ride over the past couple of years, hitting a 40-year high of 11.1% in October 2022 before returning to its 2% target for the first time in nearly three years in May this year.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “The inflation beast may have been tamed but that doesn’t mean it shouldn’t be a key factor in retirement income planning. You could be retired for twenty years or more and even the most benign of inflationary environments can nibble away at your purchasing power over that time. A period of double-digit inflation as we have seen recently can bite huge chunks out of your plans so it pays to be prepared.”
The annuity market has enjoyed a revival recently, with rising interest rates contributing to higher incomes. Data from Hargreaves Lansdown shows a 65-year old with a £100,000 pension can currently get up to £7,222 per year from a single life level annuity with a five year guarantee, more than £2,000 more per year than they would have received three years ago.
However, the level of income a client receives from an annuity does not change over time and what may seem like a healthy income today could feel “decidedly lacklustre” in twenty years’ time, says Morrissey.
Clients can benefit from annuities that rise in line with inflation. An RPI-linked annuity is currently offering up to £4,540 per year for a 65 year old with a £100,000 pension. An annuity that rises by 3% per year will start off paying up to £5,157. However, both are far lower than a client would receive with a level annuity and requires clients to live longer to unlock the value. Hargreaves Lansdown estimates that a 3% per year escalating annuity would take 12 years to catch up with the starting income from a level annuity.
For those opting for a RPI-linked product that rose at 5% per year, it would take around ten years to make up lost ground, with lower inflation meaning it could take longer.
Morrissey said pensioners should look at all options, including annuitising in slices over time, securing guaranteed income as needed while keeping the rest of the pension pot invested. This way, clients could also benefit from securing higher annuity rates as they age and potentially an enhanced annuity if they develop a health condition.