Deeper deflation will hit pension investment portfolios and pension annuities. Many private investors are being advised that they should protect their investment portfolios, following the recent announcement of deepening deflation. The retail price index (RPI) has just recorded its biggest monthly drop since records began way back in 1948, falling from -0.4% to -1.2% in April, due admittedly in part to lower mortgage costs.
The consumer price index (CPI) also dropped, from 2.9% in March to 2.3% in April, according to the Office of National Statistics (ONS). Thing is, this ongoing RPI deflation will hit retirees who have bought an inflation-linked annuity. Standard Life has written to its 25,000 customers with an RPI-linked annuity to warn them that their pension income is set to fall, and similar annuities from the mighty Prudential will also pay out less.
Many index-linked annuities do, however, have a built-in “floor”, for which customers have to pay a premium, to ensure that annuity income will not fall below a given level. Some companies, such as Aviva (Norwich Union), L&G and Axa are not expected to lower the income they pay to retirees on their index-linked annuities.
But in spite of all this, some advisers warn that inflation could actually return sooner than expected, suggesting that retirees should still inflation-proof their pension annuity incomes by buying these index-linked annuities. As a pension contract is paying out for such a long period of time you can almost be certain inflation will be something of a problem at some stage.
Also, the twin fears of current deflation and probable looming inflation are also putting discretionary portfolio fund managers in a difficult position. If I was an investor at the moment my biggest concern is that I would have no idea whether I will face deflation or hyperinflation, and the investment policy required to deal with both is totally different. However, investors should take advantage of this extreme pricing to move between certain asset types that do well in deflation, and also those that do well in inflation.
And, moving back to annuities. It is all well and good to suggest that steps should be taken to protect against future inflation. Check out annuity quotes carefully when looking for the best annuity rates. An inflation proof annuity will have the downside of a far smaller initial income. Perhaps go for a half way house and take an income that increases at, say, 3% per annum instead.
