5 helpful ways to protect your retirement income from the effects of inflation
You may have started to find the news stories about inflation a little familiar by now. The rising cost of goods and services has been in the headlines for over a year, and despite some easing, it looks set to stay that way for a little while longer.
The Office for National Statistics (ONS) announced that inflation in the UK was 8.7% for the year to April 2023, meaning that goods and services that cost £100 in April 2022 now cost £108.70.
If you’re saving for your retirement, you might be wondering how the price increases could affect your income and, as a result, the lifestyle you can expect to be able to enjoy during your post-work years.
Read on to learn more about how inflation could affect your retirement income and some steps you can take to protect your wealth.
Inflation can affect your retirement income differently depending on your circumstances
Even though it can be scary to see headlines about how quickly prices are rising, it’s important to remember that your finances are yours alone. This means that, depending on how you have invested your wealth and how you choose to spend your money, inflation may affect you differently from the next person.
Some examples of how inflation could affect your retirement savings differently are:
The balance of your portfolio
Some sectors and asset classes are more vulnerable to the effects of inflation than others. So, depending on how your portfolio is balanced, you could see some investments affected more than others.
Your lifestyle
The national rate of inflation is an average that the ONS takes from assessing a range of commonly used goods and services. If you tend to purchase different goods or services, you may be affected differently.
Your other savings
You may have some cash, or near-cash, savings. While cash is often seen as a relatively “safe” way to hold wealth, the interest rates on easy access savings accounts are unlikely to keep pace with inflation. According to Moneyfacts, the highest rate of interest on an easy access savings account as of 7 June 2023 is 3.85%.
So, depending on how much of your wealth is held in cash, you could find that the buying power you hold falls over time.
How long you have until you retire
Of course, the time frame that you have to build up your retirement savings can affect how much of an influence inflation could have on your expected income. A shorter time frame means that you have less time to boost your pot, so rising inflation might pose a greater challenge to you than someone who has many years until they expect to retire.
5 simple steps to protect your retirement income from the effects of inflation
Fortunately, there are lots of things you can do now to give yourself the potential to avoid inflation affecting your retirement plans. Here are five options you could consider.
1. Ask your planner to create a cashflow forecast
Cashflow forecasting is an invaluable tool for understanding what your retirement income might look like and the different factors that could affect whether you have enough money to live on when you finish working.
Your planner will enter some data about your income, expenditure, assets, and key dates, as well as some assumptions about inflation and investment returns. The software can then generate a chart forecasting how much income you could be able to take in retirement.
A forecast like this can help you to understand whether you are on track for the lifestyle you’d like in retirement. It can also help you to spot any potential shortfalls in income based on the data your planner has entered.
Having this model in front of you means you & your planner can create a financial plan that builds your financial resilience which could help you to cope with price rises between now and your retirement date.
2. Consider indexing any protection plans you have in place
While your investment portfolio and other savings are an important part of retirement planning, another key area that can sometimes be overlooked is your financial protection.
In other words: how would you or your family cope financially if you were to fall critically ill, perhaps requiring specialist care?
It’s important to make sure you have the correct financial protection in place to help protect your finances from the consequences of a potential illness.
You may be wondering what this has to do with inflation though.
Well, let’s say you have taken out a critical illness policy that will pay out a lump sum of £100,000 on diagnosis. If you take the policy out today with level cover (this means the payout would be the same whether you claim tomorrow or in 20 years’ time), then the effects of inflation mean that, each year, the buying power of the sum assured would drop.
So, if you or your family were to make a claim on the policy in 20 years’ time, you’d likely find that the payout hasn’t kept pace with inflation, and it cannot buy quite as much support as you hoped it might.
However, if you choose to index-link your policy when you take it out, this means that the sum assured would rise in line with inflation each year, provided you agree to the increase. It does also mean that your monthly premiums rise too, but most providers offer you the ability to postpone the rise for a certain period of time if you wish to.
If you choose this option and then make a claim on your policy in 20 years’ time, your payout will be more likely to have kept pace with inflation. This means the policy will have done its job and protected your family’s finances much more effectively than a level-cover policy.
3. Check your State Pension eligibility
For many retirees, the State Pension provides a helpful boost to their annual income.
In the tax year 2023/24, the full State Pension is almost £204 a week, or £10,600 a year. Thanks to the government’s “Triple Lock” guarantee, the value of the State Pension will rise each year either by the same level as inflation, wage growth, or 2.5%, whichever is highest.
To be eligible for the full amount, you need to have at least 35 years’-worth of National Insurance contributions (NICs) on your record.
You can use the government website to check how much of the State Pension you are eligible for and how many years of qualifying NICs you currently have.
If you notice that you have gaps in your NICs record that could prevent you from accessing a full State Pension (and subject to eligibility) you might consider buying additional credits to make up the difference. It costs £824 to buy a full year of NICs. Given that this could add up to £275 a year to your State Pension, it could be a worthwhile investment. Ordinarily you can buy credits for the preceding six years, but until April 2025 you can buy credits for years that go as far back as 2006.
Before you buy any extra credits, though, it’s worth checking to see if you might be eligible for additional credits for free. There are some circumstances in which you are eligible to receive NICs even if you weren’t employed, including if you were:
Caring for a child
Off work due to illness or injury and not earning enough in Statutory Sick Pay to qualify
Caring for someone who was sick or disabled
On Statutory Maternity, Paternity, or Adoption Leave and Adoption Pay
Unemployed.
If you’re not eligible for free additional credits, it may be helpful to consult with your financial planner before buying any, since it’s not suitable for everyone.
4. Balance your portfolio to give your investments the opportunity to keep pace with inflation
Your pension is likely to be one of your main sources of income during retirement, so it’s crucial that you ensure it has the potential to keep pace with, or ideally outpace, inflation.
Of course, returns are never guaranteed, and the value of your investments can go down as well as up. But ensuring your portfolio is balanced appropriately is a helpful way to give it the opportunity to grow as you need it to.
This requires you and your planner to assess carefully your personal attitude towards risk and to choose investments that are suitable for your personal circumstances and your specific goals. Once they have this information, your planner can help you to create a portfolio that offers you the greatest chance of building up a nest egg that is equipped to withstand the effects of inflation.
5. Consider buying an annuity
If you’re still saving for retirement, you may be some way off from deciding whether you’d like to buy an annuity or not.
However, if you’re concerned about how inflation could affect the buying power of your retirement savings once you finish working, this might be a helpful way to create peace of mind. If you buy an annuity, you could have a guaranteed annual income for the rest of your life.
Some annuities can also be index-linked, meaning your income would rise with inflation each year. This can mean you are offered a lower initial income, but you may feel that the reassurance of the inflationary increases is more valuable to you than a higher starting rate.
Depending on your circumstances when you do come to retire, an annuity may not be suitable for you. So, make sure you speak to your planner before you go ahead with one, since you usually can’t change the policy after you’ve purchased.
Get in touch
If you’re concerned about how inflation could affect your retirement income, we can help. Email theteam@fortitudefp.co.uk or call us on 01327 354321.
Please note
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.
The value of your investments (and any income from them) 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. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
The Financial Conduct Authority does not regulate cashflow planning.
Note that protection plans typically have no cash-in value at any time and cover will cease at the end of the term. If premiums stop, then cover will lapse. Cover is subject to terms and conditions and may have exclusions. Definitions of illnesses vary from product provider and will be explained within the policy documentation.