Can Your Pension Cope with Inflation Risk?

27 June 2022
8 min read
Icon Text

High inflation is back. And for pensioners, this draws out the pitfalls of conventional retirement income solutions. Existing approaches are mostly vulnerable to periods of high inflation, which can be devastating for pensioners’ standards of living.

Meanwhile, we have just increased the monthly payout rate across all the fund vintages of AB’s off-the-shelf flexible income drawdown offering, Retirement Bridge, with effect from 1 July 2022. The payout increases generally exceed inflation, typical annual DB pension increases, and the recent state pension increase.

The payout rates for Retirement Bridge Funds are reviewed for sustainability as at 1 April each year. The review predominantly takes into account the current cost of annuities alongside investment performance over the preceding year and looks to adjust the payout rate accordingly.

Payout results from Retirement Bridge, since it launched in 2015, indicate that this approach can give retirees a competitive and growing level of income in retirement which can help offset the impact of inflation. It can also help maintain sufficient capital to give retirees a good probability of annuitizing later in life on attractive terms.*

Early Annuitization Comes with Drawbacks

We believe there are some significant risks to taking an annuity upon or soon after retirement. Firstly, despite recent improvements to annuity terms, they remain very expensive by historical standards and so retirees risk locking into unnecessarily low incomes. Secondly, retirees are likely to be tempted to forego buying an inflation-linked annuity because this enhancement would further reduce their immediate income levels. As we are now seeing, this can be a very costly omission. In the display below, we show how a starting amount of £100 has eroded in real terms over every 10-year period since 1949.

HOW DAMAGING HAS INFLATION HAS BEEN IN THE UK?
Pound Sterling a Suspect Store of Value 1949

Historical analyses do not guarantee future results.

Each line represents the real value of an initial £100 over rolling annual 10-year periods between 1949 and 2022. For example, the first period is the change in £100 between 1 May 1949 and 30 April 1959. Next is between 1 May 1950 and 30 April 1960. The last period is between 1 May 2012 and 30 April 2022. Note that the Bank of England started targeting inflation (equivalent to a 2% level of CPI) in 1992 and rolling periods for which these targets are applicable have been marked in a darker grey.

As of 30 April 2022. Source: ONS and AB

Thirdly, giving up access to capital early may reduce retirees’ flexibility and lifestyle choices prematurely.

In our view, taking an annuity makes much more sense later in life, at around age 75–80, when longevity will be the main risk retirees are facing. By that stage, pensioners’ lifestyle choices will mostly be made, and they may be able to secure better annuity terms (if, for instance, their health has deteriorated).

Bridging the Gap Between Retirement and Annuitization

We think a multi-asset investment strategy is the most versatile and effective way to provide a low-cost bridging income drawdown solution. Our Retirement Bridge Fund range mirrors our better-known Target Date Funds, with an added income-paying function. In Retirement Bridge, each retiree invests in a multi-asset fund based on their year of birth. So, for instance, an investor aged 65 would choose the Retirement Bridge 1957 Fund. The Retirement Bridge Funds are structured in one-year intervals and adapt to members’ needs as they change with age. So, for instance, the 1957 Fund’s asset allocation is continuously monitored and managed within the appropriate risk parameters for this age. Crucially, the asset mix of this fund is managed to retain enough exposure to real assets like equities and property to help generate a growing level of income and to help stay ahead of inflation.

Each Retirement Bridge Fund also features an income payout that’s reviewed once a year and that’s clearly expressed in pounds and pence per unit. We set the income rate to maximize the potential investment income while minimizing the risk that the income will need to reduce. The starting income rate is similar to that of a typical joint-life level annuity—but the Retirement Bridge Funds’ income is expected to grow over time.

Retirees investing in the Funds under a pension trust arrangement retain the freedom to amend their wishes as to what happens to the remaining fund on death. Meanwhile, they can keep control of their money for longer and redeem at any time with no exit charges.

At age 75, investors have the option to annuitize or to redeploy their Retirement Bridge Funds into other investments. We provide a further multi-asset solution, the Evergreen Income Strategy, for retirees who prefer to stick with a flexible income drawdown approach.

How Does Retirement Bridge Compare with Competing Products?

We believe there are very few directly comparable products to Retirement Bridge available in the UK today. Despite George Osborne’s groundbreaking pensions freedom reforms, the market has still not evolved to provide effective, low-cost income generating solutions that enable retirees to retain access to their invested capital and help combat inflation.

Meanwhile, current annual income increases from traditional with-profits annuities are mostly very low. Defined benefit schemes provide annual income increases, but these are typically capped at between 2.5% and 5.0%—well short of the inflation levels UK retirees are experiencing today.

Has Retirement Bridge Worked?

Three key tests for our Retirement Bridge concept are the growth in income, growth in capital and the ability to annuitize more favourably after deferment. Taking the 1957 Fund as an example:

Original terms. At the time of the 1957 Fund’s launch (May 2015, when a Retirement Bridge investor would have been 58) a £20,000 pension pot could have bought a level annuity * with annual income of £822 per annum.

Growth in income. With £20,000 invested in Retirement Bridge 1957 Fund at launch, the starting annual income would have been £792 per annum, a 3.6% discount to the level annuity. But the 1957 Fund’s current income will now have grown to £851 per annum (once the increase announced in April 2022 comes into effect in July 2022), 3.5% more than the level annuity.

Growth in capital and ability to annuitize. The £20,000 original investment in the 1957 Fund would now be worth £21,045 and could be converted into a level annuity with income of £934 per annum (as of 31 March 2022). That’s an income uplift of 13.6% compared with purchasing the level annuity in May 2015.

On that basis, Retirement Bridge has demonstrated its capability to grow both income and capital, to preserve the option to annuitize in the future when terms may be better and so help to provide a better standard of life for retirees.

Time to Take Stock

The return of high inflation comes as a wake-up call to the retirement savings industry.

The industry has largely failed to rise to the challenge of the freedom and choice reforms, in terms of providing good-value decumulation products that generate reliable income streams and can help retirees cope with the changing risk landscape, including inflation. We believe retirees and scheme sponsors can and should migrate to more flexible, low-cost post- retirement multi-asset default solutions. Retirement Bridge shows the way.

For investment professional use only. Not for inspection by, distribution or quotation to, the general public. INVESTMENT RISKS TO CONSIDER

The value of an investment can go down as well as up and investors may not get back the full amount they invested. Capital is at risk. Past performance does not guarantee future results.

The Retirement Bridge Funds are available as default investment funds through UK registered pension savings schemes and seek to meet the requirements of a broad range of persons. They do not take into account an individual’s personal circumstances and may not be suitable for a particular individual or group of individuals with complex financial or personal circumstances.

Some of the principal risks of investing in Retirement Bridge Funds include:

Market Risk: The market values of the Fund’s holdings rise and fall from day to day, so investments may lose value. Interest Rate Risk: Bonds may lose value if interest rates rise or fall—long-duration bonds tend to rise and fall more than short-duration bonds. Credit Risk: A bond’s credit rating reflects the issuer’s ability to make timely payments of interest or capital—the lower the rating, the higher the risk of default. If the issuer’s financial strength deteriorates, the issuer’s rating may be lowered and the bond’s value may decline. Allocation Risk: Allocating to different types of assets may have a large impact on returns if one of these asset classes significantly underperforms the others. Foreign Risk: Investing in non-UK assets may be more volatile because of political, regulatory, market and economic uncertainties associated with them. These risks are magnified in assets of emerging or developing markets. Currency Risk: If a non-UK asset’s trading currency weakens versus sterling, its value may be negatively affected when translated back into sterling terms. Reinsurance Risk: The underlying fund(s) is accessed via another insurance provider, also known as a reinsurance arrangement; creating a direct counterparty exposure. In the event of default by an insurance provider, the value of the assets will likely fall, which will be reflected in the value of our Fund price.

Important Information

The views and opinions expressed in this document are based on our internal forecasts and may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice or an invitation to purchase any security or other investment. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This document is not an advertisement and is not intended for public use or additional distribution.

The information contained here reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. AllianceBernstein L.P. makes no guarantees or representations as to, and shall have no liability for, any electronic content delivered by any third party, including, without limitation, the accuracy, subject matter, quality or timeliness of any electronic content.

Retirement Bridge is available as a default investment fund through UK registered pension savings schemes and seeks to meet the requirements of a broad range of persons. They do not take into account an individual’s personal circumstances and may not be suitable for a particular individual or group of individuals with complex financial or personal circumstances.

Note to UK Readers: This document is issued by AllianceBernstein Limited, 50 Berkeley Street, London W1J 8HA, a company registered in England under company number 2551144. AllianceBernstein Limited is authorised and regulated in the UK by the Financial Conduct Authority (FCA – Reference Number 147956).

The [A/B] logo is a service mark of AllianceBernstein and AllianceBernstein® is a registered trademark used by permission of the owner, AllianceBernstein L.P.

© 2022 AllianceBernstein L.P