An Ernst & Young report commissioned by MetLife revealed that inflation of just 4.4% would erode pensioners’ spending power by as much as 65% over the next 25 years. Pensioners are also being hit hard because such a large proportion of their income goes on food and fuel – both of which have increased at far more than the current overall inflation level.
A significant part of the problem is that many pensioners’ incomes are fixed. A level annuity is one which pays out the same amount for the duration of the product – it stays the same even though the value of this fixed amount is constantly eroded by inflation. Research from Standard Life warns that those with a pension pot of £80,000 buying a level annuity, will spend their whole monthly income on basic living costs, such as food and fuel within 20 years of retirement.
When you are about to retire and your pension provider sends you the documentation regarding your retirement options chances are you will receive details of a level annuity. Not only that but it will probably not take account of whether or not you have a partner, quoting single life rather than the joint life you would prefer. This is pretty much the default and for many it is a poor option.
There are other options:
1. An index-linked annuity is tied to the rate of inflation
2. An escalating annuity rises at a fixed rate each year, regardless of inflation. Some years the rise may be greater than inflation, some years it may be less.
3. You can even link your income to the ups and downs of investments although this can obviously carry more risk.
4. Level annuity – all of the other options are likely to offer a lower starting income than the equivalent level annuity so some people will opt for this if, for example, they do not expect to live long enough for inflation to matter that much to them.
5. An enhanced annuity is available for those in ill health – this can be significantly more than the standard annuity. According to MGM Advantage around 40% of people could be eligible for an enhanced annuity.
6. A mixture of different annuities.
So, whether your interest is in getting more money from your annuity because you are in poor health, passing your annuity income on to your partner should you die, or protecting your income from inflation make sure you investigate all of the options. Whatever you do, don’t just accept what your provider offers you as you approach retirement – investigate it yourself or seek professional advice.