Talking Point 

Inflation double edged sword for pension freedoms

Inflation double edged sword for pension freedoms

Inflation is “a double edged sword” for those facing the prospect of retirement. 

With the UK in what appears to be an inflationary environment, helped in part by the sterling depreciation in the wake of Britain's vote to leave the EU, retirement savers face a challenge to ensure their income is not eaten away.

“Rising inflation and the potential for higher interest rates present a double edged sword,” suggests Nick Dixon, investment director at Aegon.

“On the one hand higher rates on cash and annuities boost income, but rising inflation also erodes the value of that income over time.”

“Part of the solution lies in avoiding ‘return-free’ government bonds and using low volatility equity dividends as a core component of income planning,” he explains. 

“If the bulk of income comes from natural yield, capital volatility can become less important in the investor’s aggregate risk profile.”

Sterling remains 18 per cent below its peak in November 2015, according to the Bank of England (BoE).

Consumer price index (CPI) inflation rose to 1.6 per cent in December and “further substantial increases are very likely over the coming months”, the BoE stated in its latest monetary policy summary published on 2 February.

It states: “In the central projection, conditioned on market yields that are somewhat higher than in November, inflation is expected to increase to 2.8 per cent in the first half of 2018, before falling back gradually to 2.4 per cent in three years’ time.”

Fund manager Paul Mumford of Cavendish admits he would not be surprised if inflation actually ticks up higher than forecast.

“There are a number of incoming factors that look likely to put upwards pressure on inflation - the living wage, higher import costs as a result of sterling's fall, and a potential rise in the oil price to name a few,” he points out. “It is difficult to see what the counter-force will be to keep inflation at around the current level.”

As retirees continue to grapple with the decision to take income drawdown or an annuity, understanding the potential impact of inflation on savings and investments and knowing how to mitigate the effects will be crucial to meeting income in retirement.

Architas investment director Adrian Lowcock, advises: “For investors seeking income the return of inflation means they need to target those assets which are able to grow ahead of inflation. 

“One of the biggest challenges facing investors is that traditional income assets have suffered from the reflation story with bond yields falling and investors switching from the defensive equity income stocks into cyclical growth stocks. Income seekers need to review their income assets and ensure they are suitable in a more inflationary environment.”