Time to shop around at retirement

Aston Goodey, director of sales and marketing at MGM Advantage, highlights the importance of using the Open Market Option to secure the best retirement solution.

For those nearing retirement, it is hard to overstate the importance of shopping around for the most suitable annuity. As the UK recovers slowly from the financial crisis, a rise in living costs is further undermining the perilous finances of those in retirement. Over the past year, we have highlighted the need for people to use the Open Market Option to secure the best financial retirement solution. Now this is more crucial than ever.

Inflation is increasing partly because of rising fuel prices - an essential commodity for aolder people who rely heavily on heating. Results from a recent study we conducted show that three-quarters (77%) of UK adults have been forced to cut back on necessities such as gas and electricity. We hear of cases where pensioners have to ration their income in retirement.

The rise in inflation is also a key issue 
in the minds of advisers. In recent research 
we conducted with IFAs, 83% thought the 
risk of inflation could cause an increase in demand for investment-linked retirement income options.

RPI to CPI switch

The inflation figures of the last decade show a worrying disparity between the two measures of inflation, the Retail Price Index (RPI) and the Consumer Prices Index (CPI). Many company pension schemes are linked to the RPI, and the government's proposed switch to CPI to determine annual increases to pension savings could leave many pensioners out of pocket.

The government's call for a new CPI/RPI combined price index could provide some public assurance, but whatever measure is used, inflation at 4% (as currently) could reduce the real value of £10,000 to just £6,649 over ten years.

Retirement longevity

The squeeze on finances is exacerbated by longer lives, and the need to make retirement savings last longer. The latest analysis from the Department of Work and Pensions states that more than two million people who are already over the age of 50 will reach their 100th birthday.

Cost of living increase

Household income is being increasingly squeezed. UK households will need to find an extra £33bn to maintain the standard of living enjoyed 12 months ago because of CPI rates rising to 3.7% in December 2010 - this equates to £528.96 per person.

A typical UK household will need to spend an extra £1,360 a year to maintain the standard of living they enjoyed last year. The corresponding figures for households where the main occupant is aged 65-74 is £786, and for older households, it is £579.

Worryingly, there is the potential for a domino effect on the finances of those in retirement, as increased prices coupled with longevity of retirement compound the issue.

Annuity rate drop

Annuity rates continue to fall at an alarming rate. Our most recent Annuity Index reveals that conventional rates fell 8% between June 2009 and December 2010. These rates will continue to be squeezed with a growing retired population, and with new regulations such as Solvency II, annuity providers must be innovative and develop products that can mitigate these pressures.

The sharp decline in annuity rates means many people will receive less from their retirement income. The difference between conventional and enhanced annuity rates is significant, and people approaching retirement must be diligent in what retirement income package they choose.

Safeguarding retirement income

One way to safeguard your retirement income is to buy an escalating RPI annuity that tracks the rate of inflation. However, your starting income will be far lower than for a level conventional annuity, and it could take a number of years to make up the difference.

Another option is to purchase an investment-linked annuity which allows you to invest in real assets, and it also has the potential to provide a natural hedge against inflation.

For those people who want to have a little more flexibility with their retirement income and avoid the effects of rising inflation, last year we launched a unique investment backed annuity - the Flexible Income Annuity. This offers customers the potential to receive a greater income than through a fixed level conventional annuity. The flexibility to change income levels at different stages of retirement provides the potential for growth needed and a way of negating the effects of inflation.

The overall message remains that more needs to be done to educate and encourage those nearing retirement to search the market for an annuity which is best suited to them and which offers the highest possible income throughout their retirement.