Pension saving tips: How to ‘inflation proof’ your retirement savings | Personal Finance | Finance
With inflation now at 5.4 percent, its highest level since 1992, it is imperative that Britons find a way to keep their savings afloat. People may find it difficult to make their income go as far in retirement during periods of high inflation.
Ian Burns, Principal at the pensions consulting and services firm Buck, discussed the potential implications and consequences of inflation for pensioners and older people.
He said: “The major risk of inflation is the erosion of the purchasing power of your final pot at retirement and, potentially, continued erosion through retirement.
“It is not the amount of your retirement income that matters, but what you can buy with it. So it is extremely important for a defined contribution member to think about how to protect the purchasing power of their pot from the impact of inflation.
“Individuals will often not notice the impact of month-to-month price increases on their spending power but persistent inflation over and above the return they make on their savings can have a massive impact.
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A proportion of their benefits are often indexed in line with inflation up to a cap which can be as low as 2.5 percent. Current inflation is typically above these caps meaning that the purchasing power from their pension income can be reduced.
Mr Burns also offered some practical advice for those saving for retirement during times of high inflation.
He said: “The two big factors influencing your retirement pot are how much you put into the pot and how you invest in the pot. Both will be driven by your investment time horizon and understanding your future income needs.
“It is important to contribute a percentage of salary when combating inflation in pension fund savings. Your pension contributions will then increase in line with salary growth which will likely be higher than inflation over the full course of your career.
“Furthermore, increasing your contributions at the point of receiving an annual pay rise will make saving for retirement more palatable as the immediate impact on your day-to-day spending power will be felt less.”
It is vital for people to inflation proof their savings, and Mr Burns explained how this can be done.
He said: “Savvy investors will often have a plan already in place to hedge the impact of inflation, even if the main driver is the choice of investment funds offered by their employer’s pension scheme.
“These individuals typically hold long term pension schemes or ISA savings in a diversified portfolio of assets that aim to provide a real return above inflation. Fund options will include investments in equities, property or infrastructure assets.
“The trade-off is accepting the increased risk of loss and short-term market volatility so investor time horizon remains an important factor.
“For those with the ability to invest for the long term – 10 years and above, equities are typically viewed as a natural asset class in which to invest when looking to generate returns above inflation.”
Mr Burns explained that investing a regular amount every month rather than a large lump sum can help smooth out the increased volatility of equity investment.
He suggested that the dividends provided by equities may also be attractive and should grow in line with inflation. The dividend yield is currently around 3.2 percent on the FTSE 100.
Mr Burns concluded: “Other funds that hold real assets, such as property and infrastructure, that provide contractual income linked to inflation may also be useful to combat inflation and provide diversification from equities.
“For those closer to retirement who want the certainty of an annuity (now the minority, with most people taking a flexible approach to retirement), choosing an inflation linked annuity will help protect the real value of income in retirement.”
