How is inflation affecting retirement savings and pensions?

21 February 2024

Inflation, the seemingly unstoppable rise in the prices of goods and services, affects nearly every aspect of our lives. For those carefully saving for their golden years, understanding how inflation affects pensions is crucial to securing a comfortable retirement.

The UK inflation rate rose by 9.6% in the year to October 2022 – the fastest increase in four decades. Despite falling to 6.3% in August 2023, it is still unusually high.

From fuel and groceries to mortgages and other housing costs, the impact of the recent increases is being felt by individuals and families across the UK. One area where inflation's impact can be particularly significant, and is sometimes overlooked, is pensions.

The impact of inflation on pensions

Inflation can create a problem for anyone in retirement. First, it means increased retirement costs because expenses like groceries, fuel, clothing and travel become more expensive over time. This can put a strain on your finances.

You may also find that inflation reduces the real value of your income. If parts of your retirement income are fixed, such as with a level annuity, the purchasing power of that income will decline over time as prices rise. However, you may have the option of safeguarding against this with an inflation-linked annuity.

Another issue is that, as inflation increases, the real value of money you have saved into a pension scheme decreases. Say you have £100,000 in pension savings and, for the purpose of this example, inflation settles at 3% annually. 

If left untouched, in ten years that same £100,000 will have the purchasing power of just £74,409 in today's money. We would hope of course that by investing your retirement savings during your working life, your money will benefit from investment growth that outstrips inflation in the long-run.

Government initiatives to address the impact of inflation on pensions

The UK government has taken some measures to address the challenges posed by inflation on pensions. 

Perhaps most significant is the triple lock guarantee, which works to protect the purchasing power of the State Pension from the effects of inflation. The triple lock guarantee ensures that the State Pension increases each year by the highest of the following: CPI inflation, average earnings growth, or 2.5%. 

In addition, the government has introduced automatic enrolment in workplace pensions to encourage more people to save for their retirement.

Strategies to protect your pension from inflation

While inflation can seem like a daunting challenge to overcome, there are several strategies you can consider which might help you to lessen its impact:

Increase your contributions

If you haven’t retired yet, consider contributing more to your pension plan each year. One approach is to contribute a percentage of your salary each month, rather than a fixed amount. This can help to combat the effect of inflation on your pension savings as your contributions will rise every time your salary increases.

Invest wisely

Consider investing your pension savings in assets that historically outpace inflation such as stocks and property. Remember of course that these investments are typically higher risk, which needs to be weighed up against the potential for greater returns over the long term. 

A financial adviser can suggest changes you can make to your investment strategy, such as diversifying assets (splitting the risk over a number of high, medium and low risk investments) to help protect your savings and maximise returns.

Consider inflation-linked products

If you choose to purchase an annuity then some pension products, such as inflation-linked annuities, are designed to adjust with inflation. These products offer lower initial payouts than level annuities, but they can help protect your purchasing power during retirement.

Your two options for escalating annuities are:

• Increase income in line with inflation. Increase your annuity income payments in line with the Retail Prices Index (RPI). This tracks the average change in certain goods or services bought in the UK, so it protects the buying power of your annuity income.

• Increase income at a fixed percentage. Increase your annuity income payments by a fixed percentage each year – typically 3% or 5% per annum. 

Thinking about purchasing an annuity for your retirement income? Discover how much income you could achieve with our free online tool.

Delay retirement

Unless you have to retire for medical reasons then delaying your retirement even by a year or two can have a significant impact on your pension savings. Not only does it give you longer to save and for your savings to grow, it also reduces the number of years you'll need to rely on your pension income.

Defer your State Pension

The State Pension increases by 1% for every nine weeks that you put off claiming it, or around 5.8% for each full year. This currently equates to an extra £47.28 every four weeks for each year that you defer your State Pension. If you don’t need your State Pension right away then this is a way to increase the amount you do receive and help combat the rising cost of living.

Regularly review your pension plan

Keep a close eye on your pension investments and make adjustments as needed. As you get closer to retirement, consider shifting your portfolio towards more low-risk, stable investments to safeguard your savings. You may wish to consult with a financial adviser who can help you develop a retirement plan tailored to your specific needs and financial goals.

Talk to Retirement Line about your annuity options 

If you are 55+ and thinking about accessing all or some of your pension savings soon then our friendly Annuity Specialists are here to help you. In addition to answering your questions about annuities, they will also check the annuity rates you can achieve based on your individual circumstances. 

You can speak to our friendly team today by calling freephone 01733 973038 or request a free call back here. Alternatively, use our annuity calculator for a quick review of how much income you might expect from annuity.