Retirees need new ways to manage inflation

Oksana Patron

25 October 2022

Retirees need a new approach to wealth management in the face of growing inflation or they will risk potential wealth and income destruction, according to Challenger.

Given that retirees need to make their money last for around 24 years, way longer compared to 13 years during the last major inflation crisis in the 1970s, they would need a different approach to managing inflation or risk a “period of sustained wealth destruction”, the Challenger’s report found.

According to the study, if the of inflation would be sustained at 5%, the retirees’ nominal purchasing power would be halved over 14 years.

“The impact of inflation on a retiree’s lifestyle can be dramatic even with modest inflation. With inflation of only 2% a year, one-quarter of the real value of a retirees’ income is lost after only 14 years,” the report said.

“The risk from moderate inflation is stark, 5% a year would halve their purchasing power over the same period.”

Therefore those in postretirement phase would need to better manage their income streams through, for example, investments that would benefit from higher inflation or those that automatically adjust through a linkage to the Consumer Price Index (CPI).

This could include short-term CPI-linked bonds, which are specifically linked to inflation and considered to be effective at combatting inflation, or real assets such as infrastructure and real estate as they help provide inflation hedges due to their cash flows which tend to adjust with inflation.

Also the Age Pension had in-built inflation protection for those relying on a pension and that a traditional defined benefit pension had a very effective direct measure to assist with inflation.

According to Challenger, the alternative option for retirees could be also a guaranteed CPI-linked lifetime annuity or another innovation in lifetime annuities which could provide payments that would increase in line with either an underlying diversified portfolio or a nominated basket of market indices.

“Retirees can choose the type of inflation protection that they prefer, from none to a guaranteed CPI-linked option, to approaches that retain some market risks. This is in addition to the option to draw-down capital, adjusting for inflation as desired.

“It is also possible to use different approaches to inflation management across different components of the retirement income portfolio,” the report concluded.