Inflation-proofing

Pension advisers are warning that, with inflation likely to return in the next couple of years, investors should protect their pension income.

This week, Aon Consulting warned that “looming” inflation was the main reason final salary pension schemes are increasing their deficits in spite of the stock market rises.

“It’s hugely important to stress the relevance of inflation-proofing,” says Tom McPhail at Hargreaves Lansdown.

But inflation-proofing can often reduce the initial income from an annuity by a third, although this rises over time.

Aon calculates that a 65-year-old with a pension pot of £150,000 would receive a fixed annuity income of £10,776 a year. With inflation-proofing, this would fall to £6,814.

McPhail believes that if inflation remains at 2 to 3 per cent, this drop in income could mean it is not worth buying inflation-
proofing. But inflation of 5-6 per cent could do heavy damage to a fixed income.

He suggests that investors hedge their bets and buy both an inflation-linked and a level annuity.

Lee Smythe at Killik suggests investment-linked annuities as another way
of protecting against inflation as they tend to pay a higher starting income than an inflation-linked annuity.