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The rising cost of living (inflation) is having a big impact on household incomes in 2022. This includes pensioners, whose income might not currently stretch as far as it did last year when the UK’s inflation rate stood closer to the Bank of England’s target (2%). Yet how, exactly, is inflation affecting pensions in 2022 and what can you do to mitigate its negative effects? Below, our team at Elmfield Financial Planning in Padiham offers some answers. We hope this content is useful to you and please get in touch if you’d like to discuss your own financial plan with us over a free, no-commitment consultation.
What is happening with inflation?
Inflation refers to the rising cost of goods and services in an economy. If an item cost £1 twelve months ago and its price inflates by 5%, then it now costs £1.05. In the UK, three measures are mostly used to gauge inflation: Consumer Prices Index including owner occupiers’ housing costs (CPIH), Consumer Prices Index (CPI) and the Retail Prices Index (RPI). The second of these – the CPI – is perhaps the most commonly used.
Over the last 25 years, UK inflation has primarily hovered near the Bank of England’s (BoE’s) 2% target, with some periods where it has temporarily reached about 5%. In 2022, however, inflation now stands at 11.1%. This is the highest rate in 40 years and has largely been driven up by rising global wholesale prices for oil, gas and food.
How is rising inflation affecting pensions?
For many people on a wage, rising inflation has added financial challenges to their households. Many employers are facing constraints on their profits, making it harder to meet demands for pay rises to help workers meet the rising cost of living. Pensions have also been affected, however.
The State Pension is supposed to offer a rising income each tax year under the “triple lock” rules. These stipulate that it must go up by the highest of 2.5%, average UK wages or CPI inflation. However, this system was suspended by the government in April 2022, leading the State Pension to rise by 3.1% (rather than a widely-expected 8%). However, UK inflation rose past this as 2022 progressed – going from 5.5% in January, to 9% in April and now 10.1% (in November). This means that State Pension recipients have experienced a “real terms” income loss this year, although it remains to be seen whether the triple lock will return in April 2023.
Other pension types have also been affected by rising inflation. Level annuities offer a fixed income each year (not rising with inflation). Unfortunately, these incomes will likely have lost more value in 2022 compared to other annuity types. Escalating annuities, for instance, offer a rising income each year at a set rate (e.g. 3%). Those on an inflation-linked annuity have likely fared the best, since these go up with the retail price index. This feature is partly the reason why (along with higher bond yields) many savers are rushing to buy annuities, which are currently offering the best rates in 10 years (although income drawdown is still a strong option).
Many final salary (or “defined benefit”) pensions also rise with inflation, helping to protect the real value of certain pensioners’ incomes. These schemes provide a lifelong retirement income from a previous employer. However, many of these pensions – particularly those in the private sector – are capped at how much the income can rise each year (e.g. 5%). With inflation now exceeding many of these caps at 10.1%, a loss in real incomes may occur for some people.
Addressing inflation with your pension
One study suggests that 20% of pensioners (500,000 people) increased their pension withdrawals between April and the end of June, primarily to help cope with the rising cost of living. The worry is that this could lead many people to erode their pension savings too quickly. It is important that you keep within your “safe withdrawal rate” agreed with your financial planner. Consider speaking with him/her if you feel compelled to take more from your pension to address your expenses. There may be other options at your disposal.
Those looking to retire soon may wish to re-examine their planned retirement date. For some, the UK’s rising living costs may (sadly) mean postponing is the best decision. This could allow more time to build up further pension benefits/savings to help ensure your future desired lifestyle in retirement. It may also be wise to discuss your investment strategy with your financial planner. Fighting high inflation likely means taking on investments with higher potential returns (such as shares), but this involves higher risk and markets across the world – including in the USA – have been struggling in 2022. Make sure you are comfortable with the risk and be careful to retain a long-term view with your investments.
Invitation
If you are interested in starting a conversation about your own financial plan or investments, then we’d love to hear from you. Please contact us to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938
E: info@elmfieldfp.co.uk
