How does inflation affect my pension?

If you’re saving into a pension, chances are, it’s a defined contribution, or money purchase pension, where your contributions (and from your employer, if it’s a workplace scheme) are invested in the stock market. The amount you end up with at retirement is based on the contributions made, and investment performance. The hope is that, over decades, you’ll benefit from investment growth that averages more than inflation over the same time period. However, there will be good and bad years depending on how your investments perform and the wider economic climate, and it’s particularly challenging when inflation is high.

The majority of pension savings are invested in stocks and shares, which over long-term periods tend to provide better returns than cash savings. Shares can potentially protect pension savers from inflation as the companies you invest in may be able to increase their prices in response to higher costs, for example, to grow at the same rate or higher than inflation. But this isn’t always the case, and inflation is a major challenge for some investments such as bonds that produce a fixed income.

Whether or not your pension keeps up with inflation depends on the current rate and how your investments perform. If inflation hits 8%, for example, your pension would have to grow by more than this amount simply to keep up with the cost of living. However, high inflation periods are usually relatively short term, and the hope is that the rate will come down soon enough.

For example, let’s say that your pension is currently worth £150,000 and you plan to retire in 10 years’ time, and inflation averages just 2% a year. If your pension grows by 4% per year and you continue to pay in 8% of earnings, then it’ll be worth around £203,282 in ten years. But if inflation is 4% a year for ten years and your investment growth is 2%, then your pot would be worth £140,626 in today’s money in ten years’ time.

If your pension grew by an average of 5% a year and inflation was 4% a year, then it’d be worth £185,526 in today’s money, and you’d be able to buy more with your money than you could have with your original investment ten years ago.

Rebecca O’Connor, head of pensions and savings at interactive investor, said: “The impact of inflation on the value of pension pots is really dramatic and quite scary, particularly for those already worried their pension isn’t going to be enough.

“Every percentage of growth counts in times like these. But then again, it’s unlikely that high inflation will last for many years. So if you still plan on investing for several years, don’t panic. The real growth might look disappointing for a year or two, but in time it should recover.”

Author: wpadmin

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