Is inflation costing you a comfortable retirement?

With prices rising at a record rate, you may be concerned with the short-term impact that inflation is having on your day-to-day expenses including your energy bills and the cost of a weekly shop, but there are longer term implications that need to be considered to ensure you are not impacting your ability to retire in comfort. 

Simply put, inflation refers to the rate at which the price of goods and services rises in an economy. During periods of high inflation, as we are experiencing now with rates expected to reach 13% before the end of the year, the buying power of your money is declining more rapidly. For those considering stopping work or who have recently done so, this may be even more of a concern, as the income you had planned for, may not be enough to sustain the retirement that you hoped to enjoy.

How much will I need in retirement? 

Unfortunately, there is no ‘one size fits all’ approach to how much you will need in retirement as this will very much depend on your unique lifestyle. The Pensions and Lifetime Savings Association (PLSA) works to help individuals answer this question by producing an annual ‘Retirement Living Standards’ report to understand what type of lifestyle retirees can expect, based on different levels of income. As a minimum for an individual, the PLSA suggests an income of £10,900 per annum would be required, increasing to £20,800 for those hoping for more financial security and flexibility and increasing further to £33,600 for those hoping for more financial freedom and a more luxurious retirement. If you are wondering 'What is a good pension pot?' you can read our article.

Regardless of how much you feel you may need; it is essential to ensure you are considering the impacts of inflation over this long-term horizon. For example, for a 60-year-old who has just retired and is planning an income of £30,000 per year, the impact of a 2.5% annual rate of inflation would mean the same lifestyle would cost just over £49,000 by the age of 80 (representing an increase of 64%!), and that’s without considering the high levels of inflation that we are currently experiencing. 

What is the impact of inflation on my retirement?

Using lifetime cash flow modelling, we have looked to understand what the current levels of inflation may mean to those who are approaching retirement and what additional level of savings may be required in order to mitigate the impact. 

As a starting point, an individual who retires at the age of 60, with expectations of spending £20,800 per annum, increasing in line with a 2.5% rate of inflation, would require a pension pot of £380,000, assuming a medium growth rate of 4% per annum and a 20-year time horizon. This requirement increases to £640,000 for an individual hoping for a more luxurious retirement spending £33,600 per annum. 

When looking at the impact of high levels of inflation, we have assumed a rate of 10% over the next two years, reducing to 5% for the following five years, and 2.5% for the remaining thirteen years. The same client, looking for an annual income of £20,800 would require £455,000, representing an increase of £75,000 at the start of their retirement. Using the same assumptions, an individual hoping for a more luxurious retirement would require just over £800,000 representing a staggering increase of £160,000. This substantial increase is partly due to the fact that the second individual would become a higher rate taxpayer 6 years earlier, compared to if inflation had remained at a constant rate of 2.5% throughout their retirement. 

Although these figures may be worrying for individuals who are approaching, or who have recently retired, there are a few ways of helping to mitigate the impacts of rising inflation on your retirement savings. 

Top tips to maximise the value of your retirement savings

For those who still have a number of years until they plan on retiring, you may have the flexibility to save more to mitigate the negative impacts of inflation, but if you are approaching, or have recently retired, there are a few simple steps you can take, to help maximise your chances of achieving your desired retirement. 

Maintain a diversified portfolio:

One of the best ways to protect yourself from rising inflation is to ensure you are invested in a well-diversified portfolio that invests in a range of real assets, including equities, fixed interest, property and commodities.

Historically, these asset classes have helped investors to protect their wealth against rising inflation, however, not all asset classes react as expected. It is therefore equally important to ensure that you are invested in a combination of these investments that meets your attitude to risk and your objectives for retirement.

Assess your income strategy: 

In some cases, holding cash to supplement your income may be a good way of ensuring you are able to meet your ongoing expenses, however, holding more cash than you require could have greater implications during this high inflationary period. With interest rates that still remain well below the current levels of inflation, it is likely that you will find it harder to keep up with the increased cost of living. 

Assess your existing pensions:

By understanding the charges you pay for your pension and the income flexibility they provide can go a long way in maximising your income. Significant fees can have the detrimental effect of eroding the value of your pot over a long horizon. With a pot of £300,000, a 0.5% reduction in costs could save you over £65,000 over a 20-year time period, assuming a growth rate of 4% per annum. Also, by ensuring your provider offers all of the options for flexibility of income, including phased tax-free cash, this will enable you to structure your income in the most efficient way and reduce the tax you will pay.

If you would like to discuss your options for retirement or to understand how cash flow planning may be able to assist you in provide clarity on your upcoming retirement, please get in touch and one of our experienced financial planners would be more than happy to introduce this to you.

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Please note: A pension is a type of investment. The value of investments can fall as well as rise, and you may not get back what you originally invested. The information contained within this article is for guidance only and does not constitute advice which should be sought before taking any action or inaction. The Financial Conduct Authority (FCA) does not regulate cashflow modelling.