With retirees now living for about twice as long post retirement, compared to the last major inflation crisis in the 1970s, inflation is posing a greater risk to Australian retirees than ever, according to a new report from Challenger.

“Retirees have become silent casualties of the surge in inflation, and many must now rethink their whole approach to wealth management,” says the report’s author, Aaron Minney, Head of Retirement Income.

“Given retirees have to make their money last, on average, for around 24 years compared to 13 years in the 1970s, finding a solution is critical to the health of the economy.”

The Challenger report has been released as inflation in Australia and around the world is hitting new generational highs.

Older Australians now need a different approach to managing inflation or risk a period of sustained wealth destruction, Minney finds.

The report said the loss of the purchasing power of investments in the 1970s, when cash, fixed income and equities all posted negative real returns over the decade was a grim lesson for retirees and their advisers. Current retirees are living longer than previous generations and need income over a longer time frame.

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

Investment options for managing inflation

The report notes the challenge for retirees is not only to manage expected inflation risks and generate higher than inflation income returns, but also manage income if inflation is higher than expected.

“In retirement, it is the impact of inflation on income streams that has to be managed. What is needed is an investment that benefits from higher inflation, or even better, automatically adjusts through a linkage to the Consumer Price Index (CPI),” the report notes before commenting on investing options that could help combat inflation. These may include:

• Short term CPI-linked bonds, specifically linked to inflation, are generally considered to be effective at combating inflation.
• Real assets, such as infrastructure and real estate, can help provide inflation hedges because the underlying cash flows, such as rent, tend to adjust with inflation.
• The Age Pension has in-built inflation protection for retirees that receive a pension.
• A traditional defined benefit pension has a very effective direct measure to assist with inflation as generally payments are increased in line with inflation.

An alternative option for retirees could be a guaranteed CPI-linked lifetime annuity. The annuity pays the retiree an income stream for the rest of their life that adjusts in line with CPI changes.

Another innovation in lifetime annuities has been to provide payments that increase in line with either an underlying diversified portfolio or a nominated basket of market indices. There are some differences among these options, but their effectiveness to help combat inflation is similar. However, this does not mean that the market-linked payments will always grow faster than the CPI. They go up and down in line with investment markets.

Retirement product innovation offering new ways to manage inflation risk

The report concludes that the growing range of retirement income stream options provide retirees with new ways of managing the impact of inflation.

“It is important to generate an income stream that compensates for inflation, and this is more important than managing the real capital value. Innovations in recent years provide more products for retirees to generate income and has expanded the ways that retirees can manage inflation. This gives them a better chance to manage one of the three key risks in retirement: inflation.

“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,” it concludes.