Rising prices could hit annuity incomes
After a decade of relatively benign inflation, prices are expected to rise by 4% over the next 12 months. This will particularly hit anyone with cash held in low or zero-interest paying accounts or who buys a level annuity.
A ‘level annuity’ is a type of annuity that pays you the same amount of regular income from the start of your retirement until the end of any guarantee period, or until you die. There were 41,526 level annuities sold in 2020 compared to just 7,092 escalating annuities, while data from the Association of British Insurers suggests that more than 5 million annuities could be exposed to rising prices.
According to calculations by investment firm AJ Bell, based on Office for Budget Responsibility (OBR) inflation projections, someone with a £20,000-a-year level annuity at the start of 2021 could see its real value slump by 12% by the end of 2025.
Tom Selby, head of retirement policy at AJ Bell, said: “Inflation can be a silent destroyer for savers and retirees – particularly those who lock their hard-earned savings into level annuities or stash their cash in zero-interest paying bank accounts.
“Given there are over 6.1 million annuities in payment at the moment and level annuity sales outnumbered escalating annuity sales by 6:1 in 2020, over 5 million retirees look set to feel the pinch in the coming years.
“Based on official projections, someone with a level annuity could see their spending power drop by 12% by the end of 2025 as a result of inflation. The same would be true of anyone who has their savings stashed in a current account paying 0% interest.
“What’s more, anyone who cashes out their retirement pot and shoves the money straight in a bank account risks a double whammy of paying unnecessary tax and then having the value of that pot eaten away by rising prices.”
How to combat inflation
The re-opening of economies around the world means most countries are now expecting a spike in prices – although how long this will persist for is far less clear.
Investment experts say that anyone with large sums of money saved in a cash product should review their portfolio and make sure they are getting the best interest rate available.
For medium and longer-term savings, those wanting to combat inflation may need to consider taking some investment risk with their funds. This will give your money the chance to grow over time, although markets can be volatile over the shorter-term.
“It is vital for those planning to invest their money – whether in an ISA, pension or elsewhere – that they understand the risks and build a balanced, diversified portfolio so all your eggs aren’t in one basket,” said Selby, “Anyone wanting to buy an annuity should make sure they provide any information which could boost their rate, such as details of illnesses or lifestyle factors that could limit life expectancy. You can also buy annuities that have inflation protection baked-in, although you will get a lower initial rate as a result.”