Don’t be quick to rule out having a rising income in retirement

A recent ABI report says that 43% of people don't take any financial advice before buying an annuity. At first glance when making their choices, why would anyone take an index-linked annuity when, at current rates, a 65 year old male taking a single life policy with no guaranteed payment periods, having a pension fund of £500,000 would receive a level annuity of around £27,500 but an RPI-linked annuity of just around £15,300?
 
However let's consider the following points:

The value of money has almost halved in the last 20 years. Even at the Government's target inflation rate of 2%, the value of a retiree's money could easily halve over the years in which they are retired

Things that retirees spend a greater majority of their income on are increasing in price at a faster rate than standard inflation measures - for example, energy costs are up 170% in the last 10 years, and food prices have increased well beyond Consumer Price Index (CPI ) rates in the recent past

In our experience, the vast majority of people choose a level income when purchasing an annuity because they do not perceive the value of an increasing income - mainly because of the catch up time required and the overall time taken to be ‘in pocket'

When looking at the time taken to be ‘in pocket' many people underestimate their life expectancy - the wealthier you are, the longer you are likely to live
 
As noted above, millions of annuity purchases are undertaken without financial advice and therefore there is a great potential for the risks of inflation in retirement to be misunderstood. A level income may be the right answer if you have other assets to call on when inflation starts to bite, but it would be best to undertake some form of cashflow projection before making any decision. What might seem a good level of income on the first day of your retirement might look a bit paltry 20 years later.
 
The main problem is that many individuals will consider their position today and not think much further ahead than that. Those that do consider the future very often underestimate their life expectancy. Most may note the average life expectancy of a 65 year old as being 20 years or so but fail to realise that to get an average there are likely to be many people living well beyond the average to take account of those not so fortunate.
 
Certainly those with substantial pensions and other wealth are likely to be living well beyond the average as statistics show. Consider also that if you are a couple planning retirement there is an increased likelihood that at least one of you will have a long life. In most circumstances, where health issues are not present at the time of planning, it would be sensible to take a cautious approach and assume that you will live well into your 90s at least.
 
Once you take a potential longer life into account, taking some form of rising income doesn't look quite so bad. Even if a level income is still the right option, it will bring into focus the need to have a fall-back position when inflation inevitably starts to eat into the buying power of the income being received.
 
Retirement is probably one of the biggest decisions that someone will make in their lifetime and doing so without advice from a professional could lead to the wrong outcomes and if an annuity has been purchased, not one that can be changed at a later date.

By Andy James, advice policy manager, Towry