How inflation might affect your retirement savings

In recent months you will not have missed the headlines that the UK is experiencing the highest inflation rate since the early-1980s.

While the rate fell back slightly in August, the Office for National Statistics reports that prices rose by 10.1% in the year to September 2022. Essentially, goods and services that cost £100 a year ago cost £110.10 today.

There are many ways soaring prices affect you, from the rising cost of filling up your car to the erosion of cash savings. Inflation can also affect your retirement in a range of ways – read on to discover how.

Inflation could be good news if you are still saving for your retirement

If you still have years to go before your retirement, your main concern might be sustaining your pension savings as your income is squeezed. Indeed, research by Scottish Widows has revealed that 11% of UK adults have already cut back or stopped their pension contributions.

Thanks to the power of compounding, pausing or reducing your contributions now can have a sizeable effect on your eventual pension fund. Figures from AJ Bell show that a 30-year-old on a salary of £30,000 who pauses contributions for three years could end up with a fund £25,000 smaller at State Pension Age.

If you can maintain your pension contributions now, there could be future benefits.

As a consequence of global uncertainty, stock and bond markets around the world have fallen back in recent months. What this means is that you can typically buy more shares, bonds, or fund units for the same investment.

As markets recover, the investments you make now could have the greatest growth potential, boosting your long-term returns.

As American investment legend Warren Buffett says: “Be fearful when others are greedy, and greedy when others are fearful.”

Consider where you draw your income from in a volatile market

If you are approaching retirement and considering how to structure your retirement income, inflation could have a dramatic impact.

The table below shows what income you would need in 20 years’ time to maintain the same purchasing power as today, assuming inflation at 2%, 5% and 10%.

Source: Inflation calculator

In simple terms, even if inflation were to remain at the Bank of England’s target of 2%, if you retired now on £50,000 and wanted to maintain your purchasing power, you would need an income of more than £74,000 a year in 2042.

Of course, the higher the inflation rate, the greater your income will need to be in the future to keep pace. Consequently, the pot you will need to save will be greater.

We can use sophisticated cashflow modelling to make assumptions for different levels of inflation in the future. This can help you to ensure you have “enough” to maintain your lifestyle, even if inflation continues to remain high.

Annuity rates have risen sharply in the last few months

If you are at retirement and making decisions about how you draw your later-life income, you may be considering an annuity.

When you buy an annuity, you essentially hand over a lump sum to an insurer in return for a guaranteed annual income. You may also choose other benefits, such as index-linking your income or providing a spouse’s pension when you pass away.

While rates on annuities have been in the doldrums for years during a sustained period of low interest rates, they have become much more attractive in recent months. In fact, Actuarial Post reports that annuity rates have risen by 35% over the past year.

As an example, someone aged 65 with a £100,000 pension can now get an annuity income of £6,637 a year (based on a single life, level, five-year guarantee). In September 2022 the same individual would only have received around £4,900 a year.

With many choices available to you at retirement, it does pay to speak to an expert. Many decisions cannot be reversed when made, so seeking advice can ensure you draw your desired income sustainably and tax-efficiently.

How the State Pension may be affected by inflation and what this might mean for your income

One positive effect of the current high inflation rate is that it is likely to provide a significant boost to the State Pension from 2023.

Under the terms of the government’s “triple lock”, the State Pension rises annually by the greater of:

  • The average percentage increase in prices, measured by the Consumer Price Index for September
  • The average increase in wages, measured in July (this is 5.5% in 2022)
  • 2.5%.

With the inflation rate set to remain high in September, the annual State Pension is set to increase significantly – especially as the government has reaffirmed their commitment to this increase.

This is Money report that, if the 9.9% inflation rate from August was used, pensioners on the post-2016 full rate State Pension of £185.15 a week or around £9,600 a year would see a rise to £203.50 a week or £10,600 a year.

Get in touch

Inflation can affect your retirement plans in a range of ways. We can help you to build a robust plan that considers periods of high inflation, and give you bespoke advice on how to build and draw your pension sustainably and tax-efficiently.

Email enquiries@bowmorefp.com or call us on 01275 462 469.

Please note

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

Bowmore Financial Planning Ltd is authorised and regulated by the Financial Conduct Authority.

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