Pension increase in exchange for foregoing future inflation - advice

danlightbulb

Hi all,

My Dad has been offered the option of taking a substantial increase in his pension now, in exchange for fixing that pension for the rest of his life.

He currently gets around £5k per annum for this pension and under the offer it will increase to around £7k per annum.

But the link to RPI will be removed.

Based on 3% RPI, this gives a break even point of about 12 years in the future (he is 60 now). But RPI is currently quite low, at the current rate of about 1% this makes the break even point about 30 plus years into the future.

He is very tempted by the option, as over the next 12 years it gives him over £20k extra which is considerable. In future he should be able to mitigate the loss of link to RPI by finding a decent interest rate savings account for the extra he doesn't spend.

Is there any reason he shouldn't do this?

kidmugsy

(i) How's his health? Does he have a wife?

(ii) Typically the inflation-protection you get with a DB pension is ludicrously expensive to buy in any other way.

(iii) I wouldn't be at all surprised by some noticeable negative inflation in the next few years. But I wouldn't like to bet on it until the death of my widow.

Put otherwise: he proposes to sell his inflation-protection. What else does he expect to do to hedge the risk?

[Deleted User]

The problem is that none of us know how long we will live ...

danlightbulb

kidmugsy wrote: »

(i) How's his health? Does he have a wife?

(ii) Typically the inflation-protection you get with a DB pension is ludicrously expensive to buy in any other way.

(iii) I wouldn't be at all surprised by some noticeable negative inflation in the next few years. But I wouldn't like to bet on it until the death of my widow.

Put otherwise: he proposes to sell his inflation-protection. What else does he expect to do to hedge the risk?

Health is ok at the moment. Yes he is married (to my mom).

It is very tempting for him, and I cannot find a good reason to advise him otherwise. If inflation was higher, or we were talking a bigger pension at risk then it wouldn't seem such a good idea, but it's a fairly small pension with a significant immediate boost. He is of the opinion that the money will be much more useful to him over the next 12 years, rather than having more money when he is too old to make the most of it. I find myself agreeing with his position, and my mom agrees too.

AnotherJoe

I'd agree with you as well Dan. Take the extra money now and enjoy it whilst he's in good nick.
So what if it's inflation proofed when he's dribbling away aged 90.

neilvw

Has he checked his State Pension age? If he's 60 it will be between 65 years 3 months 21 days and his 66th birthday.

https://www.gov.uk/calculate-state-pension

Has he obtained a State Pension statement?

https://www.gov.uk/state-pension-statement

This will have inflation protection (CPI) and indeed will be triple-locked (highest of CPI, average earnings growth and 2.5%) until at least 2020.

grey_gym_sock

looking at "best" annuity rates on HL's site (just as a quick check - not suggesting buying annuities from them), for a 60-year-old, £100,000 could buy a level annuity of £4,930, or a RPI-linked annuity of £2,722. that is c. 80% more for the level annuity. a similar uplift from £5k would take you to £9k, not £7k.

that suggests that this swap is a good deal for the pension provider. though that doesn't necessarily imply that it's a bad idea for your dad.

but IMHO it's more about his priorities than about whether he's likely to come out ahead under either option. i.e. supposing the £7k pension is only worth a fraction of that after 20 years' inflation, would he still have enough income from his other pensions (inc. state pension)? and would the higher initial pension let him go for some spending in early retirement that he couldn't otherwise do?

GunJack

grey_gym_sock wrote: »

looking at "best" annuity rates on HL's site (just as a quick check - not suggesting buying annuities from them), for a 60-year-old, £100,000 could buy a level annuity of £4,930, or a RPI-linked annuity of £2,722. that is c. 80% more for the level annuity. a similar uplift from £5k would take you to £9k, not £7k.

that suggests that this swap is a good deal for the pension provider. though that doesn't necessarily imply that it's a bad idea for your dad.

but IMHO it's more about his priorities than about whether he's likely to come out ahead under either option. i.e. supposing the £7k pension is only worth a fraction of that after 20 years' inflation, would he still have enough income from his other pensions (inc. state pension)? and would the higher initial pension let him go for some spending in early retirement that he couldn't otherwise do?

with this info, could you not negotiate with the provider, and maybe come to an agreement of £8k-ish??

If you don't ask.......

danlightbulb

Are you saying that my Dad could go with a different provider and get a better fixed rate?

grey_gym_sock

danlightbulb wrote: »

Are you saying that my Dad could go with a different provider and get a better fixed rate?

no: you said the pension is already in payment, which i think rules out transferring it to another provider.

looking at annuity quotes was just as a comparison, to get an idea whether changing it is good value.

saver861

Difficult question that one.

Tempting in the current climate of low inflation but that's the main risk.

I don't see inflation rising anytime soon, but thats purely a layman's perspective. I'd be inclined to do a little research on potential inflationary pressures not that you will garner anything concrete. However if it was to stay low even until he gets his state pension, then he would be well in - unless inflation spirals. At least his state pension should be inflation proof.

As others have said, I'd be trying to see if there was a better deal on the table though. Usually you can shift them a little bit and every bit helps.