Sound Financial Group Blog

That is the question and it has taken on a much greater importance given the current very low yields on inflation linked gilts. 

When you get to retirement it all sound very easy – collect your pension, put your feet up for a while and then go off and do all those things that you didn’t have time to do beforehand. However as pensioners on level (non-escalating) incomes will verify, when inflation rises and incomes do not, doing many of the things that you want to do may have to be reconsidered.

In an ideal world we would all retire with an index-linked pension and not have to worry too much about whether or not the Government meets its inflation target and the Chancellor has to read yet another letter of explanation as to why from the Governor of the Bank of England. However as the following figures show, it is increasingly difficult to be able to afford or maybe even justify, a full index linked pension when annuity rates are so low.

The following example assumes a 65 year old man in good health, with a pension fund of £500,000 buys a pension with 100% of the income being paid to his spouse on his death – assuming the best annuity rate available in the open market;

Index-Linked income - £19,500 pa

Level/Non-escalating income - £30,750 pa

There is a massive difference of over £12,000 pa to start with and it will be around 19 years (to age 84) before the index-linked annuity matches the level income (assuming the rate of inflation is at 2.5% pa). Clearly the higher the rate of inflation the quicker the escalating pension will close the gap. Furthermore it would take approximately another 15 years for the total gross pension received to be the same! Or at the annuitants age 99!

There are of course many factors that will determine which option may be chosen with pension funds when they are vested, including health, required income levels, tax position, need for tax-free cash, expected inflation rates, etc…However with annuity rates being as low as they are, many retirees will be wondering whether it’s worth the additional cost of securing an index-linked income and may instead look at alternatives. 

If you wish to discuss your own retirement planning strategy or would just like a second opinion on your current pension arrangements, please contact us and take advantage of a no cost or obligation meeting.