The latest comments by Eddie George, Governor of The Bank of England, show that inflation is unlikely to fall in the short term.
We have regularly highlighted the fact that savers are struggling to find interest rates high enough to combat the effects of inflation, one such article can be found here. However there is a hidden peril that affects the older generation, something now known as ‘Silver Inflation’.
We thought we would take a look at ‘Silver Inflation’ and its effects on pension income.
So, what is ‘Silver Inflation’?
It has long been thought that the traditional methods of calculating inflation, namely the Consumer Prices Index (CPI) and the Retail Prices Index (RPI) do not reflect the actual inflation rate suffered by older consumers. This is because the basket of goods used to calculate both RPI and CPI were not believed to be representative of the purchasing habits of older consumers.
This theory seems to have been confirmed by Age UK Enterprises who have worked with former Bank of England inflation specialists Fathom Consulting and come up with a Silver RPI measure to highlight the growing gap between the more traditional methods of inflation and the actual inflation rate suffered by those later in life.
They used information from the Living Costs and Food Survey (LCF) to re-weight the 78 items that make up the official RPI to better reflect the expenditure patterns of over 55s. The measure is the first to consider inflation at five year age bands above 55 years of age and unlike existing Office of National Statistics (ONS) pensioner measures includes all housing costs and households at all income bands.
Just how much of a difference is there?
The Silver RPI measure shows that since the start of 2008 those aged 55 or over have had to endure prices rises of almost 2% above that of the RPI figure, for those over the age of 75 the figure rises to 4%.
Age UK Enterprises calculate that the gap between real and headline inflation over that period has cost the average 60 year old £620 a year, rising to over £700 for someone aged between 65 and 69, more detail is given in the table below:
|Age band||Percentage difference between real and headline RPI||Ave cost/year**|
|55 – 59||1.8%||£500|
|60 – 64||2.6%||£640|
|65 – 69||3.3%||£710|
|70 – 74||3.8%||£690|
**The additional costs faced by older consumers is calculated by multiplying the difference in percentage change in prices faced by each age band and that faced by the population as a whole since January 2008. This is then multiplied by the average weekly expenditure for that age band and finally multiplied by the number of weeks in a year (52) to establish the annual cost of this extra inflation.
Why is there such a difference?
A primary reason for this has been the fall in mortgage interest rates which has had less effect on those in later life who are less likely to carry mortgage debt. This means that overall costs for those in later life have not reduced as greatly as for the population as a whole and, in addition, they have faced cost increases on items where they spend proportionally more such as utilities.
Based on the research conducted by Age UK Enterprises it would seem that the level of inflation suffered by older generations is far more significant that the traditional measures of CPI and RPI.
What affect does this have though on financial planning and pension income?
The coalition government have introduced their much publicised triple lock guaranteeing that the State Pension will rise in line with earnings, inflation or 2.5%, whichever is the greater.
On the face of it the restoration of the link between the State Pension and earnings, with the guarantee that if prices are rising more quickly than earnings any rise will be linked to the higher figure is good news. However the Silver Inflation measure puts into context the fact that even with the triple lock the value of the state pension will slowly be eroded.
Occupational Pension Schemes generally have some form of indexation built in, which may be linked to CPI or indeed RPI, however it is often capped. We have seen how Silver Inflation has risen at a greater level than both of these measures over the past few years, if this continues the income from Occupational Pension Schemes will be reduced in real terms.
When it comes to Personal Pension Plans the majority of people purchase Lifetime Annuities with most, in our experience, opting for a level Annuity, meaning that the income it produces will never rise. Whilst this gives a higher starting income than if an element of indexation is included, the buying power of the Annuity will start to reduce quickly.
Even if indexation is selected and set to keep pace with RPI the buying power could be eroded as we have seen how the real inflation rate suffered by more elderly consumers is higher than RPI
How can I get my savings to keep pace with inflation?
We have written many times about the problems savers have trying to get a return to match CPI, one such article can be found here. At current interest rates savings need to be tied up for at least one year for a basic rate taxpayer to get a net return equal to CPI.
There are currently no deposit accounts which provide an after tax return sufficient to beat RPI.
A higher rate taxpayer cannot get a return, net of tax, that beats CPI and there are certainly no accounts which provide even a gross interest rate which will match the Silver inflation measure.
This is particularly problematic as many more elderly savers rely on interest to supplement their pension income, with interest rates already being low, higher than expected falls in the buying power of that income are bad news.
What do we learn from looking at Silver Inflation?
The most startling revelation is the rate at which older generations suffer higher inflation than they perhaps believed was the case.
Furthermore the statistics from Age UK Enterprise shows that RPI in itself is a less meaningful figure the older you get and also the importance of focusing inflation calculations on specific age bands.
Finally the figures really emphasise the importance good quality financial planning and of doing everything you can to try and combat the effects of inflation.
Sadly though, it would seem that however hard you try your income and savings are unlikely to keep pace with the new phenomenon that is known as Silver Inflation.
If you are considering retirement or have concerned about how Silver Inflation will affect you do not hesitate to call us today on 0845 074 7778 or 0115 933 8433 and ask to speak to one of our advisers. Alternatively to do your own Annuity quote visit our free to use Annuity Calculator by clicking here.