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Rising inflation – what it means for your pension

We take a closer look at what rising inflation could mean for your pension.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Helen Morrissey
Senior Pensions and Retirement Analyst

Published on 11 February 2022

This article is more than 6 months old

It was correct at the time of publishing. Our views and any references to tax, investment and pension rules may have changed since then.

Inflation is on the rise. In recent months it’s soared past the Bank of England’s (BoE) 2% target and hit 5.4% in December – the highest level in 30 years. There’s no sign of it slowing down either with the BoE recently saying it’s expected it could hit 6% by spring and to remain high for the rest of the year.

There are lots factors behind this – the rising price of petrol, surging gas prices and supply issues caused by Brexit, and the pandemic pushing up the cost of even the most basic food items. It’s put even the most robust finances under pressure. And with energy prices set to surge by 54% when the new energy cap comes into force in April, further belt tightening will be needed.

This isn’t personal advice. If you’re not sure what’s right for you, ask for financial advice. Remember, pension and tax rules can change, and benefits depend on your circumstances. You also can’t usually take money out of a pension until at least age 55 (rising to 57 from 2028).

What does this mean for pensioners?

Inflation affects pensioners differently to working people. While everyone’s finances are affected by rising inflation, it’s something pensioners need to be particularly aware of.

Recent ONS data showed pensioner inflation was the same as for non-retired households, but it’s constructed differently. So, while rising petrol prices were driving inflation pressure more for non-retired households, it was more housing related costs – for instance energy bills – for retired households. Food is another key component with the prices of lots of basic items like margarine, milk and crisps rising at well above inflation.

While workers can expect rising wages to offset at least some of the cost increases, pensioners have less room to manoeuvre. The pension they retire with might have to last them 30 years and remain robust in the face of rising inflation.

The State Pension – often the backbone of people’s retirement planning is due to increase by 3.1% in April. However, given inflation could be roughly double that by then, it won’t help pensioners meet their rising cost of living.

What can pensioners do about inflation?

You have different options depending on how you choose to take your retirement income.

If you go down the annuity route, then you benefit from a secure income that will be paid for the rest of your life. You could choose an inflation-linked option. However, you need to be aware that the amount of income you’ll get when you first start taking an income will be lower. That’s because it takes account for the fact that it needs to rise over time.

This means people often go for other annuity options that offer a higher starting income. However, once you purchase an annuity, it can’t be undone. If you make the wrong decision you can’t go back. One way to manage this is to annuitise in stages over several years rather than annuitising the whole pension at once.

Another key component of people’s retirement income is cash. It’s a good idea to keep some money aside in case of emergencies – we think around one to three years’ worth of basic expenses in an easy to access cash account is sensible if you’re no longer working. However, it’s important not to hold more than you need.

If you hold too much cash over the longer term, the return you get from the interest paid probably won’t keep up with inflation. Over time this will take huge chunks out of what your money can get you.

If you decide to opt for income drawdown, you’ll have a pot of money that needs to be managed for a period that could last more than 30 years. Investment returns and withdrawal rates are important. If you take out large amounts, particularly early on in retirement, you might find you need to make cut-backs later on to account for increasing prices.

Similarly, if your investment strategy returns don’t match inflation or your withdrawal rate, you could end up with your money not being able to buy as much later on in retirement.

A flexible approach is an option to consider. Adopting a natural income strategy where you withdraw no more than the yield generated by your investments is a good way of making sure your pension remains robust over the long term. Clearly, these returns will fluctuate over time, but you can use your cash buffer to help supplement your income as and when needed. This should help you ride out any investment volatility and make sure your pension remains robust in the face of rising inflation.

All investments can fall as well as rise in value and you may not get back what you invest.

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