Whether you’re saving for retirement or have already started taking an income from your pension using drawdown, the rising cost of living could reduce the value of your pot and your spending power.

Thankfully inflation held steady at 2% in the 12 months to June, which is the government’s long-term target. Read more in our article Inflation holds at 2%.

Slowing inflation is good news for pension savers, as the higher it is, the more it erodes the value of your retirement savings. Remember however, that falling inflation doesn’t mean that prices are dropping, but that, on average, they aren’t climbing as quickly.

Here we explain the impact of inflation on your pension, and what, if anything, you can do about it.

If you’re thinking about getting professional financial advice, you can find a local financial adviser on VouchedFor or Unbiased.

Alternatively, if you’re looking for somewhere to start, we’ve partnered with independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.

Fidelius are rated 4.7 out of 5 from over 1,000 reviews on VouchedFor, the review site for financial advisors.

Saving towards retirement and inflation

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 and other assets such as gilts, property and cash.

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. Most workplace schemes are ‘‘lifestyled’, which means as you approach retirement, your exposure to the stock market is reduced and your retirement savings are moved into less risky assets. 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 soars, 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, as latest data shows.

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 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.”

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Managing inflation once you’ve retired

You’ll need the money you’ve built up in your pension to last for the rest of your life. However, whether this is possible will depend on a variety of factors, including how much you’ve saved, what you do with your pension savings, and the cost of living in retirement.

The Office for National Statistics (ONS) has a pensioner and non-retired household inflation rate, and while this is currently the same, it’s worked out differently. For example, while rising petrol prices are behind the rapid increase in inflation for non-retired households, costs such as energy bills and food make up a greater proportion of inflation for retired households.

State Pension

The State Pension often forms the bedrock of people’s retirement income and is guaranteed to rise through something called the ‘triple lock’ guarantee. This essentially means that each year, the government commits to increase the State Pension by the highest of September’s inflation figure, earnings growth, or 2.5%. You can find out more about this in our guide What is the pension triple lock?

This means that this year, the State Pension rose by 8.5% (in line with September’s earnings figure) on 6 April 2024. So those who reached retirement age on or after 6 April 2016, will receive £221.20 a week in the current 2024/25 tax year and people that retired before 6 April 2016, and receive the basic State Pension receive £169.50 a week, although the amount you’ll personally get is based on your National Insurance Contribution record. Learn more in our article What is the State Pension in 2024?

This rise was welcome news to many, and should help many pensioners meet rising living costs.

Defined Benefit Pensions

If you’re due to receive, or you’re already getting an income in retirement from a defined benefit (final salary pension scheme) this will be a guaranteed amount based on your final salary and the number of years you’ve belonged to the scheme. Defined benefit pensions are becoming increasingly rare, and are usually extremely valuable, as they provide a ‘gold-plated’ income in retirement. Find out more about this type of pension in our guide What is a defined benefit pension?

In theory, if you’re receiving income from a defined benefit pension scheme, you don’t need to worry about inflation because the amount you receive will increase alongside the rising cost of living. However, the promise to increase your pension in line with inflation may be capped up to a certain limit if you are taking benefits from a private sector defined benefit scheme, which is usually about 5%. With inflation now much lower than this you should find your defined benefit pension keeps up with living costs. Public sector defined benefit pensions usually rise alongside inflation, and are not subject to a cap. Find out more in our article How do public sector pensions work?

Your choices at retirement and inflation

If you have a defined contribution pension (which the majority of people do), you’ll be free to do as you wish with your retirement savings. This leaves various options, including pension drawdown and buying an annuity, and whether or not your retirement income increases in line with inflation will depend on which you choose, and how you manage your pension. Read more in our article Your pension options at retirement.

Pension drawdown

Pension drawdown, also known as flexible drawdown or flexi-access drawdown, enables you to leave your pension savings invested once you retire, and draw an income from them when needed. You can also take a 25% tax-free cash lump sum from your pot if you wish, or take this out over several years in retirement. Find out more in our articles What is pension drawdown and how does it work? And Should I take my tax-free pension cash at age 55?

You can decide how and when you take an income from your drawdown pension. Meanwhile, you’ll keep the remainder of your pot invested, and the hope is that future investment growth will beat the rate of inflation. This is why even when you retire it’s a good idea to keep a portion of your pension invested to give your retirement pot the chance to carry on growing in value.

However, your money needs to last for decades in retirement, and therefore it’s important to carefully consider how much you withdraw, particularly when the cost of living is rising and you may need to take out more than before. The main risk is that you end up taking too much money from your pension pot too soon, and if your investments don’t perform well, you could run out of money. Find out more about the risks in our article Should I use my pension to boost my income?

For example, according to investment provider AJ Bell, someone with a £100,000 pension who needs an income of £5,000 a year in addition to their State Pension would run out of money after 37 years before inflation is factored in, and with a return on their investments of 4% after fees. However, if inflation remained at 5% during their retirement, the same pot would run out 19 years earlier with withdrawals increased by 5% to meet the rising cost of living. When inflation is running high, the number of years the same retirement pot would last can be dramatically reduced.

This makes it particularly important to make careful use of the flexibility of pensions these days, and only take what you need from your pot to ensure your savings will last for the rest of your retirement. That’s where the skill of a professional adviser can prove particularly valuable, as they can work on preserving the value of your retirement pot.

Annuities

If you use some or all of your pension to buy an annuity, or income for life, then depending on the type of annuity you choose, inflation may or may not have an impact on your income. There are various different types of annuity. For example, you may choose an ‘escalating annuity’, which means that the amount of income you receive will increase over time to keep up with inflation. Beware, though, that the amount you receive at the start will be lower with this type of annuity as it’s expected to increase over time.

If you buy a ‘fixed annuity’, the amount you receive will not change over time, and you’re likely to receive a higher starting income. However, once you’ve bought an annuity with your pension fund, you cannot change your mind. Some retirees, for example, buy an annuity with a chunk of their pension to ensure they have some guaranteed income to cover basic bills in retirement, for example, while leaving the remainder invested. You can read more about annuities in our article Annuities explained.

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Holding cash in retirement

It’s important to keep some cash savings aside for emergencies, and generally experts recommend increasing the amount in retirement to around one to three years’ worth of living expenses in an easy access account. However, the return you’ll receive from interest paid on cash accounts won’t keep up with inflation, and will reduce the spending power of your money over time. Even so, it’s important to keep the amount you feel comfortable with and might need if, for example, you want to use this to boost your income rather than dip into your pension pot.

What can you do to beat inflation in retirement?

It’s more important than ever to find all the ways you might be able to increase your retirement income. For example, you might be entitled to Pension Credit, which is a means-tested benefit for pensioners on a low income that tops your income up to a certain level (£218.15 per week for single pensioners in the 2024/25 tax year, and £332.95 for a couple). Claiming Pension Credit may also give you access to other benefits, such as help with council tax or heating costs, so it’s important to find out if you qualify for this as it’s still a hugely underclaimed benefit. Find out more in our article Pension Credit explained and What’s in store for your pension in the new tax year?

You can receive free guidance from the age of 50 and above from the Government’s Pension Wise service on your choices at retirement. Call them on 0800 138 3944 to book a free appointment, or you can book through their website.

However, if you want advice that’s tailored to your personal situation to maximise your potential income in retirement, you can find a local financial adviser on VouchedFor or Unbiased. For more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.

If you’re thinking about getting professional financial advice, you can find a local financial adviser on VouchedFor or Unbiased.

Alternatively, if you’re looking for somewhere to start, we’ve partnered with independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial advisor. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.

Fidelius are rated 4.7 out of 5 from over 1,000 reviews on VouchedFor, the review site for financial advisors.

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