Soaring inflation – now at its highest level in 40 years – is a big concern for those who are already in retirement or soon to be.
s many retirees have a fixed – and often small – pension to get by, making ends meet can be a huge challenge when prices are soaring on so many fronts. The situation is even worse for those without a private pension. “If you don’t have a private pension and are dependent on the state pension, any increase in the state pension does not keep pace with inflation or is likely to do so in the future. “said Peter Griffin, director of APT Workplace Pensions. “So other than cutting expenses, there’s not much you can do.”
So if you’re about to retire – or are about to retire in a few years – what can you do to protect your pension against runaway inflation?
Stay invested
“You could still have 20 or more years to live if you retire at age 65,” said Brian O’Reilly, head of investment strategy at Mediolanum Asset Management. “So consider staying invested until retirement.”
You can stay invested in retirement by putting money from your retirement pool into an approved retirement fund (ARF – a personal retirement fund).
Be careful with how you invest your retirement money though.
“The old advice was that people lock everything into cash or fixed income investments (such as bonds) when they retire, but that old advice needs to be adjusted because it was based on people living much shorter than they do today,” O’Reilly said. “The older you get, the lower your risk profile becomes, as you have less time to recover from market falls – but 20 years is a long enough period for markets to fall and recover.”
Locking the money in your retirement fund into cash or bonds for twenty years would likely see a good chunk of that money erode over time, as returns may well be consistently low or even zero or negative – and there there is therefore a good chance that inflation can destroy any Return.
Avoid bonds
Bonds generally don’t do well when inflation is high and interest rates start to rise. “There are probably a lot of people looking at losses in their bond portfolios or their pensions and that can be a nasty surprise,” O’Reilly said. “This is by far the worst bond bear market we’ve seen in the last fifty years.”
(A bear market is a market where the prices of certain investments fall for an extended period of time.)
One option for conservative investors who want to stick with bonds are inflation-linked bonds, as they can offer some inflation protection, according to O’Reilly.
Opt for a multi-asset fund
A good multi-asset fund is an option for a relatively cautious investor who wants exposure to investments that will keep up with, or even outpace, inflation — but who don’t want to take on too much risk, according to O’Reilly.
Multi-asset funds invest in a range of different investments, such as stocks, bonds, real estate and commodities. This exposure to various investments should reduce the investment risk you take and increase your chances of realizing a return on your investment.
“Multi-asset funds are an area to explore if they end up with negative returns [on bonds or other investments]said O’Reilly. “Nominal assets – such as real estate, stocks and commodities – generally keep pace with inflation. You can invest in a combination of nominal assets through a multi-asset fund. Commodities are important right now – energy companies are doing very well, so from an investor’s perspective they offer some inflation protection A good multi-asset fund will offer exposure to a combination of all of those things, as well as long-term themes.
Understand exactly what a multi-asset fund invests in before investing your money in it, so you get the exact investment exposure you want. Also be sure to choose a multi-asset fund that suits your risk profile (whether high, medium or low risk) as well as your stage of retirement.
The further you go into retirement, the more you should move towards low-risk funds.
ART rather than annuity
When you retire, you usually have the choice between taking an annuity or reinvesting the money from your pension fund in an ART.
An annuity is a pension that can be purchased with money from your retirement fund when you retire. Although annuities give guaranteed income for the rest of your life, many people are shocked at the small pension an annuity buys.
It is possible to purchase an indexed annuity – where the value of your pension increases each year – to help offset any future inflation. However, indexed annuities are very expensive. You may have to wait ten or more years after retirement before you begin to enjoy the benefits of an indexed annuity.
“Unless you’re confident you’ll live a long life, an indexed annuity may not be worth it,” Griffin said.
You may have a better chance of protecting your pension against inflation in retirement if you opt for a TAR instead of an annuity, although much depends on the performance of your TAR investments. In the event that your ARF performs poorly and loses money in any given year, inflation will eat away at that fund more than if the investment performance had been strong.
You can regularly withdraw money from your TAR to provide you with an income in retirement, but you must do so in a way that does not risk depleting the fund.
“The advantage of an ARF is that it has more flexibility [than an annuity]”, said Griffon. “The problem is that if you tap into your ARF too often, everything will disappear.
Another great benefit of ARFs is that any money left in your ARF after you die can be left to your loved ones. This is not always the case with annuities.
Don’t jump the gun if you’re young
“The younger you are, the less impact today’s inflation will have on your pension,” Griffin said. “Anyone in their 30s, 40s or early 50s shouldn’t worry too much about the impact of current inflation on their pension, because current inflation is so far removed from when they will get their pension .”
Just make sure your retirement savings aren’t stuck in conservative, low-return investments when you’re young. The younger you are, the greater the investment risk you can afford to take. You’ll have a better chance of fighting inflation and building a healthy retirement fund by investing in appropriate medium- to high-risk investments from an early age.
Remember that inflation will come down over time – let’s hope it does sooner rather than later.
Get independent advice
Get independent financial advice before deciding – or making changes – where your retirement fund money is invested. “There is no magic formula when it comes to investing to try to hedge against inflation,” said Peter Griffin of APT Workplace Pensions. “Finding funds that will offer inflation protection will even be a challenge for a good investment manager. You need an advisor to help you.
Check if you have an inflation hedge
Check if inflation protection is already built into your pension. You may have a working pension where your annual pension increases each year – perhaps in line with inflation or salary increases from those who replaced you.
Don’t dive early
You may be able to draw on your pension from age 50, depending on your pension plan. Be careful when doing so in order to manage the rising cost of living.
“You can tap into a pension from the age of 50 if you’ve ever worked for a company and had a pension plan with that company – and then left that company and left the pension there,” Griffin said. “I wouldn’t recommend that you dip into a pension early to meet a short-term need like an increase in the cost of living. This short-term need may be even greater when you retire and remember that the purpose of a pension is to provide you with income in retirement.
