It is possible to do pretty much all the mathematical calculations we will ever need on a slide rule – possible, but far from probable. Just because we could, that is no reason at all for us all to rush out and buy one, just in case we might need them.
We also have a client whose career was in the insuring of passenger aircrafts; it is technically possible that all the engines could stop working at the same time, however if we believed that then air travel would simply not exist. That does not mean an aircraft will not crash, it means that is unlikely.
Probably vs possibly: the cost to a retiree
In the case of employees being switched out of their guaranteed pension at work, an employer would generally give an uplift of 25 per cent.
We know this is the right type of compensation because BECTU, the media and entertainment industry union, told us that the BBC final salary scheme cost the BBC as employer roughly 23 per cent of salary.
However, with an inflation-linked annuity, not only is the cost 100 per cent of your capital, but it also cuts your income by around 40 per cent.
A 62-year-old leaving two-third of their income to a spouse from a £500,000 pension annuity, with no increases the income is £2,606 per month (6.25 per cent); and with RPI-guaranteed increases the income falls by 40 per cent to £1,547 (3.71 per cent).
So do retirees need the cost of that word ‘guaranteed’? If you have guaranteed RPI-linked expenses then that is a case of liability matching, and do not forget you have a guaranteed state pension to cover basic costs – currently inflation linked, but who knows in the future.
Another consideration is, what happens if you decide that you can deal with fluctuations in costs by letting your lifestyle expenditure soak up the blows?
If retired, your fuel cost is not for commuting so you can travel less, you can change around your household shopping, go out or drink less, all of which adds up.
It is a lot harder to cut living costs when you are both working and juggling household bills for a family with growing children. If that is the case, is it worth paying the enormous cost to have inflation-linking guaranteed?
Guarantees are contractual, dividends are discretionary
A contractual liability is met by securing assets with a matching liability, so when an investment guarantees to match RPI the only assets with an embedded certainty of meeting that payment are index-linked gilts.
These all have different maturity dates so you will have to try and guess how long you will need one – ie when you are likely to die.
If you are 62 now, let us pick 95, so that is 33 years, meaning we want a maturity in around 2056. You are in luck, there is a Treasury 0.125 per cent maturing on November 22 2056.
What does its label mean?
Both the annual coupon (the 0.125 per cent) and the principal (the capital) are adjusted in line with inflation, RPI.
