How Inflation Affects Your Pension: From Retirees to Career-Starters

With news that UK inflation rose to 10.1% in July 2022, and is expected to rise further later in the year, the increasing cost of living is on everyone’s mind.

While people on fixed incomes such as pensions are particularly affected by rising costs, inflation can have an impact on your retirement whether you have already finished work, are approaching the end of your career or are just starting out on your saving journey.  

Early career savers: don’t let short term trends drive long term investments

Most workers in the UK save for retirement through defined contribution or money purchase pension schemes, where contributions made by you – and your employer when saving through a workplace pension – are invested on your behalf. The aim is that the investment performs well enough long-term to outpace inflation, making your money go further.

Your money is invested in a variety of assets, including bonds and property, but primarily in stocks and shares through the stock market. Stock market growth can be hampered by high inflation, affecting the value of your investment in the short term, but it is important that you remember that investing in a pension is generally a long-term commitment.

Periods of high inflation are usually relatively short lived, so although there can be a significant impact on your day to day finances, try not to pay too much heed to disappointing pension projections from year to year if you’re not close to retirement, as the likelihood is that your investment will recover in the long term, providing you with predictable pension income.

Approaching retirement? Check any changes you may need to make to your financial plans

If you do plan to retire within the next few years, it’s important to carefully consider your options in light of the retirement you would like to enjoy and take account of the different ways inflation could affect your retirement income.

If you have been saving into a defined contribution scheme, the most common type of private pension, you will have the freedom to choose how you would like to access your savings on retirement. Common choices include making use of drawdown income and annuities, and each option offers both benefit and risk.

Pension drawdown involves leaving some of your pension pot invested and drawing down an income as needed. With this option, you can access 25% of your savings tax-free, either as a lump sum or spread out over time. Leaving some of your savings invested gives your overall pension pot the opportunity to continue to grow after you stop working, however it does expose you to the risk of inflation outpacing investment growth. Careful planning is needed to accurately assess how much income to draw down, particularly in a time of rising costs of living, as taking too much too soon can reduce how long your pension can support you in retirement by years or even decades.

Alternatively, savers may choose to use some or all of their retirement savings to purchase an annuity, which offers an income for life. Annuities have been less popular in recent years due to lower interest rates and increased life expectancy resulting in lower levels of income being offered. An ‘escalating annuity’ offers an income which rises over time to account for higher costs of living, but does result in lower income in early years, which can be a struggle to adapt to when newly retired. A ‘fixed annuity’, however, offers a higher starting income but will not rise to keep pace with inflation, reducing your purchasing power over time.

Working with a professional retirement advisor – ideally the best pension income planning specialist in Scotland – will help you assess your options and plan with confidence.

Retirees: understand your changing income and spending patterns

The lifestyle you enjoy after retirement is driven by many factors, financial and otherwise, including the overall amount you saved and how you go on to spend it. You will also be affected by changes out with your control, such as the continuing escalation in energy prices.  

The State Pension forms the basis of many people’s income in retirement, and for many is the only source of income. This was increased in April 2022 to £185.15 per week for those who qualify for the full State Pension, a below-inflation increase of 3.1% while the government had suspended the ‘triple-lock’ on pension income to cut spending. With inflation having more than trebled, this represents reduced purchasing power for those relying on the State Pension.

Defined benefit or ‘final salary’ pensions offer a guaranteed income in retirement, although these are increasingly rare other than in the public sector. While the guaranteed income should increase to account for inflation and does in schemes of this type offered through public sector employers, increases in private sector defined benefit schemes are generally capped at between 2.5% and 5%.

Despite these constraints on your income, retirees are not powerless when faced with rising inflation. As well as exploring ways to boost your income, it’s important to make sure you’re taking advantage of all the support you are entitled to. Many people are unaware that they are eligible for Pension Credit, which tops up the income of pensioners on low income. If you do qualify for Pension Credit, you may also be able to access other means-tested benefits which could help ease the rising cost of living, such as help with council tax or heating your home.

Whatever your circumstances, planning is key

Whether you’re already enjoying retirement, counting down the days or decades away, rising inflation could impact your plans. Now more than ever, it’s vital to access independent expert advice.

McCrea Director and Pension and Investment Specialist Jonathan Campbell advises everyone to proactively plan for their retirement and review those plans as the economic climate shifts: “Reviewing your financial situation both prior to and during retirement is always important. However, in this current world of high inflation, it becomes even more relevant as increased costs could impact on short or long term goals and living standards.”

Wherever you are in your retirement planning journey, our experts can help – get in touch today for a free, no-obligation consultation.