The effect of 0% RPI on Pensions

Deflation or falling prices have a mixed effect on pensioners and some could lose out. The latest Retail Prices Index figure is 0% and in the coming months some prices are expected to fall further taking the index into negative territory.

So what does this mean for pensioners? There is no need to worry about State pensions because although they are linked to changes in the September RPI, there is a minimum increase every year of 2.5% and State pensions cannot go down.

Next month, April, the basic state pension rises from £90.70 a week to £95.25 a week for a single person, a 5% increase. But because pensioners spend a higher proportion of their disposable income on food and services like household repairs, where prices have been rising, pensioner inflation runs much higher than average inflation. While the January RPI figure was almost 0%, estimates put pensioner inflation in the same month at above 5%.

But the news is not so good for those who have taken out inflation linked annuities. These pensioners could find their income falling if inflation turns negative. ‘Annuities from Prudential and Standard Life could fall, while those from Norwich Union and L&G will not decrease but then will not rise until RPI has reached its previous level.

For those in receipt of a company pension from former employers, most schemes will not reduce the income to pensioners in the event of deflation. But the income will not rise, meaning that they face a rising cost of living without a rise in their income.

Pensioners suffer higher inflation than the general population yet in many cases their income will remain static because it is linked to the headline RPI figure. The current deflationary environment could well be short lived despite low inflation those who are about to retire need to give serious thought to how to hedge against inflation seeing as they could be drawing their pension for upwards of 40 years.

Retiring investors need to inflation-proof some of their pension income – where possible splitting their pension three ways between a level annuity, a 3% escalating annuity and an RPI linked annuity. Drawdown is an alternative for those with larger pots. Whatever they do it is imperative they do not ignore the inflation risk.

State pensions are to be linked to earnings by 2015 – although whether or not the government will honour this pledge remains to be seen. There have occasionally been times when inflation has outpaced average earnings in the past and there could be again in the future. The government might avoid an own goal here by linking the state pension to the higher of average earnings or inflation.

Meanwhile, those coming up to retirement and purchasing an annuity should make certain they are getting the best deal by shopping around and checking with an independent adviser who specializes in annuities. Everyone has the right to the Open Market Option which means they can buy an annuity from a provider other than the company with which they had their original pension savings scheme. Many providers rely on savers’ apathy and offer poor rates for annuities on maturing pension contracts. The difference between the best annuity and the worst can be as much as 30%.

In addition, those with health or lifestyle problems can get a higher income. New research from life insurer LV= shows that over 150,000 people who could qualify for an enhanced annuity, purchase a standard annuity instead and lose out on thousands of pounds of income. A 62-year-old man with an enhanced annuity could receive an extra £7,300 in retirement income over his lifetime.

Enhanced annuities can give people with certain medical or lifestyle conditions – for example people with high blood pressure or those who smoke or are overweight – a higher level of income in retirement. This is because enhanced annuity rates are calculated individually, based on the applicant’s personal circumstances and those with an unhealthy lifestyle or chronic medical conditions have a shorter life expectancy.

Despite the UK enhanced annuity market growing by one third in 2008, this is still a long way short of the four out of ten annuitants that LV= estimates could qualify for some form of enhancement, and a higher annual income in retirement.

Thousands of annuitants are still missing out on a higher income in retirement. Just 27,482 annuitants purchased an enhanced annuity in 2008, whereas research shows that a further 150,000 people could have qualified for one. People simply can’t afford to miss out on the chance of increasing their income in retirement.

A 62-year-old male could receive, on average, an extra £369 in income each year from an enhanced annuity, an increase of 22.7% compared with the average income from a standard annuity. This could equate to an additional £7,380 over the rest of his lifetime.

It is imperative investors seek independent advice when considering or deciding upon retirement options.