Inflation may have fallen from the 11.1% we saw in October 2022, but it is not going away.
Back then, it was partly the result of a spike in energy prices following Russia’s invasion of Ukraine.
It then remained well above the 2% target partly because of higher food prices.
But even if a solution is found, and inflation doesn’t spike, it is still likely to stay above the Bank of England’s 2% target.
It’s a global problem. But rather than geopolitics, you might be more concerned about its effect on your pension.
How inflation affects your pension
The consumer price index (CPI) rate of inflation tells us how much prices increase over a certain time period.
The rate of Consumer Prices Index inflation rose to 3.8 per cent in July from 3.6 cent in June, the Office for National Statistics said on Wednesday.
if there’s a 10% inflation rate, a product that costs £1 right now will cost £1.10 in a year’s time.
This is not too much of a problem if you are working and can negotiate a 10% salary increase. It starts to become a very serious problem indeed if you are on a fixed pension. Unless you are one of the fortunate few with an index-linked pension, the buying power of your pension income will be steadily whittled away.
Fortunately, there isn’t 10% inflation at the moment. But any inflation will have the same effect given time.
The Bank of England decided to cut the base rate from 4.25% to 4% on 07 August 2025, its fifth rate cut in 12 months.
The Monetary Policy Committee said that CPI inflation is forecast to increase to 4% by September 2025 but is expected to fall back thereafter towards the 2% target.
Even if the Bank of England hits its 2% target for acceptable inflation, your pension pot will still be shrinking in terms of spending power.
If you lived for 25 years after you retire, 2% inflation a year would mean you would need £1.64 to buy something worth £1 today. It would cost £2.38 if inflation stayed at 3.5%.
You may need a larger pension pot than you planned to deal with inflation.
But inflation also makes it harder to build up a large pot. When inflation is higher, our pension investments have to work harder just to stand still. If inflation is 5%, our investments will need to deliver 5% returns after charges just to hold their value, let alone grow.
How can you make the most of your pension?
The impact of inflation will depend on the type of pension scheme you have.
Those few with defined benefit schemes, which promise to pay a retirement income based on your salary and length of service, will be hit by inflation when they start receiving their retirement income, unless you are one of the fortunate few still with a scheme linked to inflation.
The rest of us, with defined contribution pensions face the real challenges.
If you are using drawdown and taking a flexible income while keeping your pension invested, you’ll need to consider the effects of inflation on both your investments and your income withdrawals. If inflation is high, you’ll need to withdraw more to maintain your standard of living – but doing this could mean running out of cash.
If you are planning to use some or all of your retirement pot to buy an annuity, which will give you a guaranteed income for life, you need to plan ahead. A fixed income that is generous now may look much less rewarding in a few years’ time, and downright painful in another 20.
You can get annuities which link payouts to inflation, but at the cost of far smaller initial returns.
Finding a solution
Its not all gloom and doom. Even if inflation surges again, there are ways to plan ahead and protect yourself. You need to look at the effects of inflation on your pension calculations.
There may be ways to make your pension work harder.
Then, making the appropriate investments, and ensuring that you are making adequate contributions to your pension plans and to other investments will help you have the income you need in retirement.
And the sooner you start inflation-proofing your pension, the easier that can be.
So, for a solution that works for your future, call us today.
UK inflation: What is the rate and why are prices still rising? – BBC News
Bank of England cuts interest rate to two-year low
Monetary Policy Report – February 2025 | Bank of England
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to a suitable investment strategy you should seek independent financial advice before embarking on any course of action.
A pension is a long-term investment; the fund value can go down as well as up and this can impact the level of pension benefits available. Pension Income could also be affected by interest rates at the time benefits are taken. Pension savings are at risk of being eroded by inflation.
Past performance is not a guide to future performance.
The value and returns of an investment are not guaranteed, investors may lose some or all of their investment. When investing Capital is at risk.
