5% or RPI increases - any crystal balls?

ukdw

Not sure if this is changing with the new pension IHT rules - but currently some guaranteed annuities can attract IHT I believe - based on a 'market value' - that gradually reduces as the guarantee period runs down.

market value calculator here
https://www.gov.uk/government/publications/inheritance-tax-guaranteed-annuity-calculator

Cobbler_tone

I think this thread perfectly demonstrates our personal attitudes (and circumstances) towards our future security. If buying something with RPI protection vs a 5% increase was significantly more, it would be a no brainer in my mind. 5% is a meaty increase. RPI traditionally runs well below that. Maybe a hangover from Covid?
And I’m definitely not a risky person! A large part of my pension will have protection of 2.5%-5% which doesn’t worry me. My spending patterns will be totally different in retirement. 

If you have a 5% increase and RPI ran higher for a bit, realistically what damage would it do?
If there is a catastrophic sustained rise in RPI it might relieve some worries but in terms of risk and return I know which one I’d do.
There have got to be far, far bigger risks that the same people are taking with their money. e.g. you’d be better off projecting flat pension growth and having it in cash, as the pot you are projecting to buy an annuity with could shrink considerably.
If RPI protection is going to keep you up at night, then it’s worth stumping up the extra. Choices are there for a reason and with most things it comes down to personal circumstances and attitudes and there will never be a right or wrong answer…maybe mathematically once you’re dead! 

OldScientist

DRS1 said:

Last year I bought an annuity and chose 5% increases over RPI.  I had buyer's remorse pretty quickly - second guessing myself.
So this year I am buying another annuity and have the same choice 5% or RPI.  I am tempted to pick RPI this time.  The starting annuity is nearly 15% higher with RPI than with 5%.
How would people decide which one to choose?
Just thinking it would be interesting to have one of each doesn't seem like a sensible basis to decide.

As a detail, last year I did look at historic RPI over the last 20 years and saw that it had exceeded 5% in three of those years.

In terms of working out a cross over point what rate of RPI would people assume?  If I look at a list 
of index linked gilts there is a column for implied RPI which seems to hover around the 3.1/3.2% figure but I can't believe it will stay there for the next 30 years.

It is simultaneously too late and too soon to second guess yourself over your first annuity purchase.

For your second annuity purchase, rather than looking at which one will 'win' (which is impossible to predict) another way of looking at the dilemma is to put it in context of your entire retirement plan including income and expenditure.

For example, one potential way of categorising expenditure is to divide it into 'core' (which will include housing costs, bills, everyday food, etc. and potentially some 'lifestyle' elements like a minimum of one holiday per year, eating out once per month, hobbies, etc.) and 'adaptive' expenditure (e.g., more holidays, more expensive hobbies etc).

One strategy is then planning to have the 'core' expenditure covered by inflation-adjusted guaranteed income (e.g., state pension, DB pension, and annuities) and 'adaptive' expenditure covered by (variable?) portfolio withdrawals and guaranteed income that is not inflation protected (e.g., a level or fixed escalation annuity, capped DB pension, etc.).

In other words, where certainty in real income is required, buy certainty and where not, then there's a choice, but frame that choice allowing for all income sources and expenditure requirements.

It is also useful to remember that income from nominal annuities (including those with fixed escalations) is subject to 'sequence of inflation' risk, i.e., high inflation (e.g., 10 years of 10% inflation is a reasonable proxy of 'high' inflation and not outrageous in historical terms for the UK) soon after purchase has a far worse effect on overall retirement income than high inflation towards the end of retirement.

It is also perhaps worth noting that of nominal annuities, a level one front loads income (i.e. it is higher when younger) and an escalating one backloads income (i.e., higher when older). Again, this can be a factor in making a decision.

Cobbler_tone

Reminds me of trying to deal in shares. I have some that I bought for £25 currently buying at the £80 they are today. They were £75 last week, could be £100 in a years time or £50. When do you sell them?
Not quite as volatile as dealing in Tesla shares though!

Locking in a solid growth on a pension is never going to be that disastrous over the limited course of a retirement. Neither will the share scenario if you don't need the money.

Lowtrawler

DRS1 said:

Lowtrawler said:

You've said it yourself - you would need a crystal ball to know which is better financially. Perhaps more importantly is what you are trying to achieve?

Choosing RPI increases cushions you from inflation impacts to the average person. If you spend on things the average person spends on, your buying power will remain constant over the life of the annuity.

By choosing 5% increases, you either are gambling on RPI being lower than 5% or you have a specific spend pattern which you know will increase annually by 5%.

It doesn't sound like you're a gambler and so do you have a spend pattern of 5% annual increases? If not, RPI would appear to be a more sensible choice.

I am the sort of gambler who bets on the favourite in a two horse race and watches it lose.

It looks like RPI is the favourite in this two horse race.

Personally I don't believe RPI represents a true inflation rate (certainly not my personal rate) but that is just gut feel not based on any facts.

I am also conscious that there will be a change to RPI which I perceive as a devaluing of it.  Again just a gut feel that any form of CPI is less than RPI.  No facts involved.

RPI will no longer be used from February 2030 and replaced with CPIH. You are correct, CPIH is expected to be lower although still higher than CPI.

It is no surprise you have a different view of personal inflation. RPI / CPI is a nationwide average based on a theoretical basket of goods and services. The exact mix of things you spend on is bound to be different.

m_c_s

UK Inflation (CPI) Averages
10yr	3.01%
20yr	3.02%
30yr	2.90%
40yr	3.39%
50yr	5.23%
60yr	5.52%
70yr	5.17%
80yr	5.14%

Add 0.5 to 1% to the above to get approx RPI.
Recency bias is always something to be aware of. Recent inflation history falls significantly short of longer term averages. The recent 2 year period (2022 and 2023) of above 6% inflation impacts the average of the last 10 years by adding approx 1%. To feel real pain you need 10+ years of 7 to 15% like the 1970s and 1980s. The 1970s and early 1980s in particular are the main decades which skew most inflation data averages with many years above 8% inflation and several years hitting 15%+ inflation. That is brutal and arguably a once in a generation type global scenario.

Cobbler_tone

Here is the most pessimistic of crystal balls with inflation not dropping below 4% for the next 25 and averaging 6%. It would depend on where the big numbers dropped of course.
In reality you could (pretty safely) assume that we will have years below 5% where you would catch up, unless there was that much of a gap that 5% wouldn't match the smaller % of inflation at the time. You'll be ahead of the game if you bought it today.
It also depends greatly on when you intend to die. 

Unless someone knows something and isn't telling us, 5% protection looks pretty decent if quite a bit cheaper. 

Now someone can pull it apart. 

I go back to wages. Mine will be miles off the historical run rate and I've done OK....I'm not even a resident doctor, topical.

DRS1

Cobbler_tone said:

Here is the most pessimistic of crystal balls with inflation not dropping below 4% for the next 25 and averaging 6%. It would depend on where the big numbers dropped of course.
In reality you could (pretty safely) assume that we will have years below 5% where you would catch up, unless there was that much of a gap that 5% wouldn't match the smaller % of inflation at the time. You'll be ahead of the game if you bought it today.
It also depends greatly on when you intend to die. 

Unless someone knows something and isn't telling us, 5% protection looks pretty decent if quite a bit cheaper. 

Now someone can pull it apart. 

I go back to wages. Mine will be miles off the historical run rate and I've done OK....I'm not even a resident doctor, topical.

This is where the gambling comes in.  Do I want to gamble on this sort of inflation picture in the years ahead.  Last year I was working on 4% being the average inflation rate and I can't help feeling that was optimistic.

One small point when you say "Unless someone knows something and isn't telling us, 5% protection looks pretty decent if quite a bit cheaper."  5% protection is currently more expensive because Mr Market is pricing inflation at just over 3%.  So in your table you could insert say 14k as the start point for the RPI column vs 10k in the 5% column. 

I had a good reason for going for 5% last year I know I did.  But this year I am inclined to hedge my bets.  As someone said half right is better than completely wrong.

QrizB

DRS1 said:

One small point when you say "Unless someone knows something and isn't telling us, 5% protection looks pretty decent if quite a bit cheaper."  5% protection is currently more expensive because Mr Market is pricing inflation at just over 3%.  

There was a similar confusion in an earlier post:

Cobbler_tone said:

If buying something with RPI protection vs a 5% increase was significantly more, it would be a no brainer in my mind. 5% is a meaty increase. RPI traditionally runs well below that. 

I think the commenter had got it back-to-front for some reason.

DRS1

m_c_s said:

UK Inflation (CPI) Averages
10yr	3.01%
20yr	3.02%
30yr	2.90%
40yr	3.39%
50yr	5.23%
60yr	5.52%
70yr	5.17%
80yr	5.14%

Add 0.5 to 1% to the above to get approx RPI.
Recency bias is always something to be aware of. Recent inflation history falls significantly short of longer term averages. The recent 2 year period (2022 and 2023) of above 6% inflation impacts the average of the last 10 years by adding approx 1%. To feel real pain you need 10+ years of 7 to 15% like the 1970s and 1980s. The 1970s and early 1980s in particular are the main decades which skew most inflation data averages with many years above 8% inflation and several years hitting 15%+ inflation. That is brutal and arguably a once in a generation type global scenario.

Those figures do surprise me and give me some comfort that I was not completely barking last year.

I suppose that historic stories of hyperinflation (Germany in the 1920s/30s Zimbabwe and Venezuela more recently) make one more fearful of inflation that is justified by recent years in the UK.