Affecting factors > inflation
Inflation can have a dramatic impact on your retirement income, particularly if you retire at a relatively early age.
Consider the following graph:
The effect of inflation is easily demonstrated above. Note
that the above scenario illustrates an arbitrary £100 annual pension
income at retirement. You can see that at 3% inflation, the £100 annual
pension your receive is actually worth £36 in terms of spending power
in 34 years after retiring.
Negating the effects of inflation by escalation
To negate the effect of inflation, you could consider purchasing an annuity
that is RPI (Retail Price Index) linked, although this will invariably have
a lower starting annuity rate. Alternatively, you could opt for an Escalating
Annuity, again this can prove expensive depending on the amount of escalation
you choose. Obviously a 5% annual escalation of your income will be more expensive
than one at say 2%.
Negating the effects of inflation by investment
Another way to approach the problem of inflation could be to investigate
those annuities that have an element of investment contained within, such
as with-profit or unit linked annuities. The thinking behind this is that
the investment element would increase in value with time, although you must
bear in mind that investment gains can just as easily decrease as they can
increase. The term for this type of annuity is "Investment Linked Annuity".
Inflation can also have a more obscure effect on your pension income. In times
of low inflation, insurance companies will offer lower annuity rates because
the value of the money that they pay you as income is higher and therefore
has a greater cost. If inflation is high, the payments they make to you get
devalued more rapidly (assuming constant inflation), so the payments made
by the insurance company are comparatively cheaper.
It is also important to understand that inflation affects people in different
ways, depending on your age, lifestyle, etc. You can find out more about this
by visiting the following page: inflation at the National Statistics Offices.
