The real cost of inflation for pensioners

Inflation may be running at about -1.4% a year, measured by the Retail Prices Index (RPI), but for those in retirement, the picture is rather different with a rate of 2.2% this year, having fallen from a peak of 8.7% in 2008, according to specialist magazine Pensions Insight (November 2009).

Pensioners suffer from higher inflation because of their spending patterns

The reason for this difference is that pensioners spend differently from families – in fact families at different times of their life-cycle spend differently from each other. This means that the RPI, which is based on a ‘typical’ basket of purchases of goods and services is not really an indicator of what is happening to individuals, more a broad brush guide to trends.

So while the actual inflation rate for everyone is likely to be slightly different from the published rate, the direction of movement is likely to be similar. While we are on the topic, the Consumer Prices Index (CPI) is different in that it excludes mortgages and other housing costs. This is why it is currently running well above the RPI.

Does this matter?
Because pensions are currently linked to the RPI, this difference is really important to pensioners. When state pensions are next reviewed, if the RPI is negative, the best pensioners can hope for is no increase (in theory there could be a reduction – but this would be political suicide); yet their costs are rising. In fact most private pensions are also linked to no more than RPI at best (in some cases, nothing at all or for others the RPI up to a maximum of 5%). So, again, the next review could be most uncomfortable.

Plans are in place to link the basic state pension to average earnings – which tend to rise faster than (RPI) inflation – but only if it can be afforded, which seems unlikely by the target date of 2012

An active retirement requires money

What can pensioners do?
For those who are already retired and have purchased an annuity, there are few options other than, perhaps, seeking to release some of the equity from their home in order to generate more income. (This is a highly complex area and one that should not be considered without individual professional financial advice.) Those using an unsecured pension (formerly called drawdown or pension fund withdrawal) could consider increasing the rate at which they take money from their fund, but this has implications for the value of the residual fund. It is also important to be aware that age-related limits apply to the rate of withdrawal.

Those still at work need to consider whether their contributions remain at an adequate level to provide the income they are likely to require in retirement – bearing in mind that inflation is unlikely to go away over the longer term.

There are no simple formulae to help, other than knowing that the best private sector pension schemes generally aim to provide two-thirds of pre-retirement salary as a pension. If you want to do better, you will have to become an MP.

It is important always to seek independent financial advice before making any decision regarding your finances. For further information, please contact us. The value of investments is not guaranteed; you may get back less than you put in.

NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND. 

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