Blog » How does inflation impact your pension?

How does inflation impact your pension?

October 5, 2022
The details provided in this article are for general information only and are in no way deemed to be financial advice. All of the material is correct as of the publication date, but could be out-of-date by the time you read the article.

As inflation takes a grip on spending power in the UK, millions of households are having to reset budgets, forego luxuries and think twice about saving for the future. In this article we want to show how inflation works and affects us all, but more importantly, that it is still possible to ensure future finances – such as pensions – are not sacrificed while budgeting for present day essentials. How can we ensure that our pensions are not damaged as inflation looms? Are they still the best way to save for our post-work years?

What is inflation?

Inflation occurs when prices rise across any one national economy. Simplistically, it can be put down to too much money chasing too few goods. A country’s fiscal policy can also have an effect on whether there is inflation or not. For instance, there may be an imbalance in borrowing and spending. Or rising commodity prices may affect import or export prices.

Inflation in 2022

Currently, as we approach the end of 2022, inflation has been triggered across the world due largely to the conflicts in eastern Europe. In an effort to restrict further Russian aggression, western countries have imposed sanctions. This has started a trade war where Russia, in retaliation to the sanctions, is denying western countries some of their essential exports. One of these exports is gas. Hence as supply is rare, demand is not met and prices rise. As fuel is needed residentially and for all areas of business, this state of affairs is crippling world economies.

Saving pension money into a piggy bank during inflation

How do we know when inflation will hit?

In the UK every month, the Office of National Statistics checks prices over a range of seven hundred goods which are considered essential. This is known as the CPI or Consumer Price Index. These prices are then compared to those one year ago. The change is recorded as the rate of inflation.

The Office of National Statistics records the change as a percentage increase or decrease. So, for instance, if the seven hundred items cost £1000 last year and £1100 this year, that is an increase of £100 on real everyday prices. Shown as a percentage of the initial cost, this equals 10%. On a micro-level, if a commodity cost £10 in the previous year, it is now likely to cost £11.

In the UK over the last 20 years the rise in inflation has been around 2%. This is considered a stable rate and the Bank of England attempts to keep it at this rate. But, as of September 2022, the inflation rate is 9.9% and many experts expect it to continue rising in 2023.

The Impact on Everyday Living

The first impact is a psychological one. As massive inflation hits the headlines, people feel threatened. Individuals have to create new ways to ensure their income covers all outgoings. They may try to put tighter boundaries on luxuries and refrain from saving for the future. Unpredictable prices therefore not only affect present day living but it may also devastate retirement years too.

Impacts on pension

Whenever you consider the likely pay out of a pension, you should take into consideration that inflation will erode the value of your investment. For instance, let’s say that you keep £1000 hidden away at home over 10 years. Over that time there is 10% inflation. This means that your £1000 is worth £100 less than it was 5 years ago. Inflation has eroded its value. So as much as a fund will state a specific pay out, the value of this amount will be impacted by inflation.

The State Pension

The great thing about the State Pension in the UK is it takes into account the inflation rate. It has a triple lock system whereby the State Pension amount is increased with inflation. It should be noted this system was suspended following the Covid epidemic.

Your private pension

Even though everyday private pensions do not act like a State Pension, they are likely to grow faster than inflation if the latter remains quite stable. It is when inflation grows unpredictably and exponentially things may go awry.

So, it’s important to understand how your pension is growing. This can be done by asking your pension provider for an up to date report. Is it falling behind inflation? Is it performing well?

Man in glasses reading about pensions and inflation in the newspaper

Do you have other pensions you could bring together into a better performing pension? Is this the right time to increase or decrease contributions? Pensions can be complex at the best of times and seeking the advice of a regulated financial adviser can be invaluable.

Taking your pension

When you want to withdraw your pension, you will want to know the best way of doing that without being impacted too much by prevailing inflation. For instance, if you are going to buy an annuity, an escalating annuity will attempt to keep up with inflation whereas a fixed annuity will be eroded by inflation. If you are going for drawdowns, you are likely to be affected by inflation in real time.

How can I continue to save for my pension?

This of course is not easy. The most important issue is making ends meet in the here and now. But if you do not keep tomorrow in mind, you are unlikely to be funding your future. In other words, you need to be making sure that the future is still an essential need.

A time of inflation is unlikely to be when you increase your savings but it should be a time when you are making sure that your funds are in the right place and working efficiently. Make sure you understand how well your savings and pensions are performing. As stated above, this is an ideal time to check out the efficiency of your pensions and savings (contact Human Resources or your pension provider for a current report) and make changes where needed. If you have more than one pension, this may be the time to consider moving all of your savings into the most efficient fund. Again, this should only be considered with the advice of a regulated financial adviser.

The important thing is don’t sacrifice your future to make ends meet now. Instead of reducing contributions on your pension, consider making it more effective with the funds you have. Don’t forget that if you are over 55 you can consider taking money out of your pension to help ends meet – this should only be done with the support of a regulated financial adviser.

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