When, as now, interest rates are very low and inflation relatively high, the real value of savings and the purchasing power of a fixed income are steadily eroded. This may not affect us much in the short term but over a period of years the cumulative impact is more dramatic. So, the effect on pensions may be serious.
It takes resolve to build up a useful pension pot. Although there is the incentive of tax relief, monthly pension contributions have to be found. It’s good to know this effort should be rewarded with income that, with state arrangements, will ensure healthy cash flow until the cost of living gives way to the cost of dying. Things may not be that simple.
The pensions landscape is changing. State pension age for women is already rising and, by 2020, men and women alike will have to wait until they are 66. Age discrimination law may help some to keep working longer and the upcoming National Employment Savings Trust (NEST) scheme may boost provision, but another major issue is increased life expectancy.
Medical advances and lifestyle factors lie behind improved life expectancy data. With regional and gender variations, the Office for National Statistics projects average UK life expectancy at age 65 of around two decades*. So, many of us should see lengthy retirements. These exert downward pressure on annuity rates, whilst any fixed annuity income will diminish in real terms if inflation persists.
One alternative to a level annuity is the index-linked variant, which helps ensure that the income (although less per month to start with) will broadly maintain its purchasing power. Another option that may help beat inflation is an investment annuity, where the income is derived from a mix of assets – though it could fall as well as rise, over time. A series of small annuities bought periodically can phase retirement income levels as needed.
Annuity purchase is not, however, compulsory and it is possible to take the tax-free lump sum and draw a regular amount under socalled pension drawdown. This may be capped or flexible, though the latter is dependent upon a minimum level of ongoing guaranteed income. Capped or flexible drawdown may also be phased to suit personal circumstances; individual pensions advice is always recommended.
*Period life expectancy, 2007-9, UK males 17.8, UK females 20.4 – ONS Statistical Bulletin, 8 June 2011