How inflation affects your pension

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Inflation affects more than the prices you pay today. It can also influence how much your pension savings will be worth in the future and how far your retirement income will stretch.

This does not necessarily mean inflation will reduce the amount shown in your pension. Instead, rising prices can reduce its purchasing power. Even when a pension grows in cash terms, it may not buy as much if its growth does not keep pace with inflation.

In this guide, we explain how pensions and inflation are connected, how different types of pensions may be affected and what you could consider when reviewing your retirement plans.

What is inflation?

According to the Office for National Statistics, consumer price inflation measures changes in the prices of goods and services purchased by households. These changes are tracked using a representative basket of household purchases.

As prices rise, the purchasing power of money falls. For example, £100 may buy fewer groceries, cover less of an energy bill or pay for fewer journeys than it did several years ago.

This matters for pensions because you could be saving for several decades and then relying on your retirement income for many more. Inflation can therefore affect your finances both before and after you retire.

How does inflation affect your pension savings?

Inflation can reduce the real value of your pension savings if the value of your pot does not grow at the same rate as prices.

Pension statements normally show how much your pension is worth in pounds. This is its nominal value. However, the amount those pounds will be able to buy is also important.

Nominal growth and real growth

Nominal growth is the increase shown in the cash value of your pension. Real growth is the increase after inflation has been taken into account.

For example, imagine your pension grew by 4% during a year in which inflation was also 4%. Your pension would contain more money, but its purchasing power would have remained broadly similar before allowing for fees and charges.

Similarly, if your pension grew by 3% while prices increased by 5%, its nominal value would have risen, but its purchasing power may have fallen.

These are simplified examples rather than forecasts. Your pension’s actual performance will depend on factors including its investments, contributions and charges.

According to MoneyHelper, most defined contribution pension schemes charge fees to invest and manage your money. These charges can also affect how much your pension grows over time.

Why time makes a difference

Inflation builds up over time. A relatively small annual increase in prices can become more significant when it continues across a long saving period.

Someone who is many years from retirement may experience several periods of high and low inflation. Investment performance will also vary, so pension growth may exceed inflation in some years and fall behind it in others.

Regularly reviewing your pension can help you understand whether your contributions and projected income remain aligned with your retirement plans. Our guide explains more about how much to put in your pension.

How does inflation affect different types of pensions?

The effect inflation has will partly depend on the type of pension you hold and how its benefits are calculated.

According to MoneyHelper, a defined contribution pension builds up a pot of money that can be used to provide an income in retirement. This can include both workplace and personal pensions, and the value of the pot can rise or fall. 

Defined benefit pensions provide an income based on your salary and how long you belonged to the scheme. Payments will usually increase to help account for inflation, although the rules vary between schemes.

According to the Government Actuary’s Department, the State Pension triple lock currently bases annual increases on the highest of average earnings growth, Consumer Prices Index inflation and 2.5%. However, this is government policy and could change in the future.

You can learn more about the differences in our guide to pension types.

How can inflation affect your retirement income?

Inflation remains important after you retire. An income that comfortably covers your expenses at the start of retirement may not stretch as far 10 or 20 years later.

The impact will depend partly on whether your retirement income is fixed, increases over time or remains invested.

Your personal experience of inflation may also differ from the headline figure. According to the Office for National Statistics, consumer inflation measures are based on overall household expenditure patterns rather than the spending of one particular household. Your own experience will depend on which goods and services take up the largest share of your budget.

Fixed retirement income

A fixed retirement income stays at the same cash amount.

For example, an income of £15,000 a year may initially cover your planned expenses. If that income remains unchanged while prices rise, it is likely to cover less as retirement continues.

A fixed annuity can provide a guaranteed regular income, but the payment will not increase unless you select an option that provides a rising income.

Increasing or inflation-linked income

Some retirement income can increase over time. This may help reduce the effect rising prices have on its purchasing power.

However, the way an income increases can vary. Increases may follow a fixed percentage, track an inflation measure or be subject to a cap. An increasing annuity will also generally offer a lower starting income than an equivalent fixed annuity.

Our guide to what an annuity is explains the available options in more detail.

Pension drawdown

With pension income drawdown, the money you have not withdrawn remains invested.

This gives the pot the potential to grow during retirement, which may help it keep pace with inflation. However, investment performance is not guaranteed and the value of your pension can fall.

Inflation can also lead you to withdraw more to cover higher costs. Larger or more frequent withdrawals may place additional pressure on the pot and affect how long it lasts.

The right balance will depend on your circumstances, spending needs and capacity for risk. Our guide comparing an annuity and drawdown explores the main differences.

Can inflation change how much you need for retirement?

Inflation means that planning only around today’s prices could underestimate how much you will eventually need.

The cost of groceries, household bills, travel and leisure activities could all be different by the time you retire. Your own spending is also likely to change as you move through different stages of retirement.

Pension projections may show amounts in one of two ways:

• Today’s money: An estimate adjusted to illustrate what the future amount may be able to buy at current prices.
• Future money: The estimated cash amount you might receive without expressing it in terms of current purchasing power.

Check which method has been used when looking at a pension statement, forecast or retirement calculator. A large projected figure can appear reassuring, but it may not represent what the same sum would buy today.

According to MoneyHelper, pension statements should show how much a pension is worth, how its value has changed and an estimate of the retirement income it might provide. Check the assumptions used when comparing this estimate with your expected spending.

For help assessing possible expenses, read our guide to the cost of retirement. You can also explore the factors involved in calculating pension income.

How can inflation affect pension saving behaviour?

Inflation can influence what people do as well as what their money is worth.

When household costs rise, it may become harder to maintain pension contributions. You might consider reducing contributions or pausing them while dealing with more immediate expenses.

Although this can relieve short-term pressure, paying in less means there is less money available to be invested. With a workplace pension, reducing your payments could also affect contributions from your employer, depending on the scheme’s rules.

Affordability comes first, and continuing at the same level will not be realistic for everyone. Before changing workplace pension contributions, check how the decision could affect:

• Employer contributions.
• Tax relief.
• Your projected retirement income.
• Any additional scheme benefits.
• Your ability to restart or increase contributions later.

Inflation may also make a pension appear to be progressing more strongly than it is. A rising cash balance can look positive, but its real value may have changed much less once higher prices are considered.

Equally, a short period of high inflation does not necessarily mean you should make immediate changes to long-term investments. Pension decisions should reflect your wider circumstances, retirement timeline and capacity for risk.

Read our guide to understanding pension contributions for more information.

Things to review when considering pensions and inflation

There is no single way to remove inflation risk from retirement planning. However, understanding how your pensions and expected income work can help you make more informed decisions.

You could consider:

• Checking whether forecasts are shown in today’s money or future cash values.
• Reviewing how much is being paid into your personal and workplace pensions.
• Finding out whether your employer will contribute more if you increase your payments.
• Checking whether a defined benefit pension includes inflation-linked increases or annual caps.
• Understanding whether your expected retirement income will remain fixed or increase.
• Considering how long your pension may need to provide an income.
• Reviewing whether your planned retirement spending still appears realistic.
• Seeking financial advice before making significant pension or investment decisions.

Regular reviews can be particularly useful after changes to your income, household costs, retirement plans or financial priorities.

Can you protect your pension from inflation?

There is no guaranteed way to make a pension completely inflation-proof.

Investment growth may help a defined contribution pension keep pace with or exceed inflation over time, but returns are not guaranteed. Investments can rise and fall, and past performance does not predict future results.

Some retirement income products provide payments that increase, but this usually involves a trade-off. For example, an increasing annuity may start at a lower level than a fixed annuity.

Holding different sources of retirement income may mean they respond differently to inflation. However, the most appropriate approach will depend on your circumstances and capacity for risk.

Rather than trying to eliminate inflation completely, it may be more realistic to understand its possible effects and review whether your retirement plans remain suitable.

Explore your retirement options

Inflation is one of several factors that can affect how much you need in retirement and how long your pension savings may last.

Visit the LV= pensions and retirement hub to learn more about building your pension, estimating your future income and understanding the options available when you retire.

FAQs

Does inflation reduce the amount in my pension?

Not directly. Inflation reduces purchasing power, which means your pension may buy less if its value does not grow as quickly as prices. The cash amount shown on your statement could rise while its real value stays similar or falls.

Can a pension grow faster than inflation?

An invested pension can grow faster than inflation, but this is not guaranteed. Performance depends on its investments, contributions, charges and market conditions.

Are workplace pensions protected from inflation?

It depends on the pension. Defined contribution workplace pensions do not normally guarantee growth in line with inflation. Defined benefit pensions will often include increases to help account for inflation, although scheme rules and annual limits may apply.

Does inflation affect pension drawdown?

Yes. Inflation can increase the amount you need to withdraw to cover your expenses. Your remaining money stays invested and may grow, but its value can also fall.

Are annuities protected from inflation?

Not all annuities are. A fixed annuity usually pays the same income throughout its term. Increasing and inflation-linked annuities are available, but they normally provide a lower initial income.

Should I increase my pension contributions because of inflation?

This will depend on your budget, pension arrangements and retirement plans. Increasing contributions may help build a larger pot, but it will not be affordable or appropriate for everyone. Consider your wider finances and speak to a financial adviser if you are unsure.

How can I tell whether my pension forecast includes inflation?

Check whether it refers to figures in “today’s money”, “real terms” or future cash values. Your pension provider should explain the assumptions used in its projections.