Interest rates: Expert discusses Bank of England decision making
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The Bank of England expects inflation to hit five percent as energy and food costs surge. This is be desperate news for pensioners who are either living off the interest from their cash savings or have locked into a level annuity.
An annuity is the guaranteed income for life that many pensioners buy with their retirement savings when they stop working.
They fell out of favour after 2015’s pension freedom reforms killed off the obligation to buy an annuity at retirement.
However, more than six million are still living on the income paid by an annuity taken out before then.
Of these, an estimated five million took out a level annuity, which will pay them a flat rate of income every year that does not rise in line with prices.
Retirees chose this option over an inflation-linked or “escalating” annuity, where income does rise with prices but from a lower starting point.
Somebody with a level annuity paying £20,000 a year could see its real value slump by 12 percent over five years, said Tom Selby, head of retirement policy at AJ Bell.
That means they will get £2,400 less a year by 2025, purely due to inflation.
In real terms the losses may be even greater, because pensioners spend a relatively large chunk of their income on food and energy, which are rising fastest of all.
Selby said: “Inflation can be a silent destroyer for savers and retirees. It will be particularly hard on those who lock their hard-earned savings into level annuities or stash their cash in zero-interest paying bank accounts.”
The triple lock was designed to help pensioners withstand inflation by increasing the State Pension by price growth, earnings or 2.5 percent a year, whichever is greater.
Chancellor Rishi Sunak’s decision to scrap the earnings element of the triple lock means they will get a sub-inflation increase of 3.1 percent next year.
Plunging real terms annuity income will make a bad situation even worse.
Once you have locked into an annuity, you have to stick with it for life, even if the income dwindles in real terms.
On Thursday, we reported that rising interest rates could be good news for those who are shopping around for an annuity today, as it could give them an extra £250 a year.
However, it is a disaster for five million who have previously locked into a level annuity as their income will not rise as prices soar.
Selby said: “If shopping around today, consider taking out an inflation-linked annuity to protect yourself.”
At time of writing, a 65-year-old non-smoker with £100,000 could buy an annuity paying a level income of £5,238 a year.
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That is up from a low of £4,500 a couple of years ago.
If the same person bought an escalating annuity where the income rose by 3 percent they would get just £3,395 a year at first, but this would steadily rise over time.
Today’s annuity buyers therefore have a difficult decision to make.
Helen Morrissey, senior pension and retirement analyst at Hargreaves Lansdown, said: “One option is to use use half your pension to buy a level annuity, and half to buy one that will rise with inflation.”
The other option is drawdown, where you leave your money invested and take income as needed, but then you are subject to stock market volatility.
No decision is without risk.
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