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How inflation of 18% will affect your pension

30 August 2022

Many working people are struggling with the rising cost of living today, but inflation means they are likely to find retirement even more difficult.

By Anthony Luzio,

Editor, Trustnet Magazine

Close to half of people have no idea how high inflation will affect their pension and other savings, according to new research from Schroders Personal Wealth (SPW).

A recent report from investment bank Citi claimed UK CPI could reach 18.6% by next January, driven by an increase in the energy price cap.

However, the SPW Inflation Watch Report, which surveyed just over 1,000 UK adults aged 18 to 80, found that only 54.7% of UK consumers were aware of the impact that high inflation was having on their savings.

Meanwhile, only 3.5% recognised that the impact on their savings was the biggest cost of rising inflation.

Ben Waterhouse, chief client officer at Schroders Personal Wealth, said: “The impact of today’s high inflation on everyday lives, retirement plans and pension pots has been significant. Worryingly, our survey shows many people are unaware of its effect on their cash savings and retirement plans.

“It’s important that people do understand the impact inflation can have. Many may not see the true effect until it is too late and may find that their financial goals are no longer achievable.”

He added: “There are no magic solutions to solve inflation, but we do believe that it is in times like these that the need for financial advice has never been greater.”

But pensions come in many different forms, and most people are likely to have more than one of them. So how exactly does high inflation affect each one?

First up is the state pension, which most people in the UK are eligible for. Nigel Peaple (pictured), director of policy and advocacy at the Pensions and Lifetime Savings Association (PLSA), pointed out that this benefits from the triple lock, which increases the amount of income pensioners receive, in line with which figure is higher out of inflation, wage growth or 2.5%.

“The annual rise is based on September’s inflation number, which is expected to be more than 10%, which would mean the State Pension would increase to more than £10,500 per year,” he said.

For people with a private pension, usually amassed via their workplace, the impact of inflation will depend on whether they have a defined benefit (also known as final salary) or defined contribution scheme.

“A further key issue is whether they are still saving into a pension or whether they are already retired and drawing their pension,” added Peaple.

He said that if someone is currently saving into a defined benefit scheme, inflation will have little direct impact on their future pension income, especially if their salary increases in line with inflation.

“Moreover, if they are already retired, they are likely to have some inflation protection, although often this is limited to between 2.5% and 5%,” he added. “The exact details will depend on the plan and the years in which the saving was undertaken.”

If you are paying into a pension today, it is unlikely to be a defined benefit scheme unless you work in a government job. Instead, you are likely to be paying into a defined contribution scheme, the final value of which will depend on how much money you put in and the performance of the underlying investments.

Peaple noted pension schemes and providers will ensure these are well diversified across a global portfolio, making them reasonably resilient against financial shocks – and the further away you are from retirement, the smaller the likely impact.

“However, if someone is already retired and drawing their pension, the increase in the cost of living will have an effect,” he warned.

“If they draw their pension in the form of an annuity, they may have chosen a scheme with limited inflation protection. If, as has been very popular in recent years, they are drawing their income under an ‘investment drawdown’ arrangement, they may need to consider whether to draw out more to cover their living costs. If they do this, they should remember it will result in lower income in the future.”

The Bank of England’s website has an inflation calculator that allows you to work out how much your wealth needs to grow to maintain its purchasing power.

For someone paying into a defined contribution scheme who is tempted to retire soon, Peaple said the higher cost of living and stock market volatility should make them consider deferring for a few years.

He noted that delaying retirement by a year or refraining from taking pension income for a short period of time can have a significant positive impact on retirement benefits, “especially as higher forecast interest rates will improve the purchase value of annuities”.

“Anyone close to retirement who is unsure what to do should consider seeking financial advice.

“For those who are over 50, have a workplace pension and want to make sense of their retirement options, an impartial online or telephone appointment can also be booked for free with Pension Wise, a government scheme set up to provide specialist pension guidance,” he finished. 

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