As the cost of living rises, here’s how to mitigate the risk of your pension running out sooner.

With the price of petrol recently hitting an all-time high and the price of groceries escalating considerably since lockdown, we’ve all noticed the strain inflation is putting on our personal finances.

Depending on your life stage, you may not yet have considered the impact inflation has on your pension. But, whether you’re still building up your pension savings or you’re currently drawing upon them for income, it’s crucial to understand this impact - and what you can do about it. 

First, what is inflation?

Inflation describes the decreasing purchasing power of money. In other words, inflation means that the pound in your pocket buys less now than it could have several years ago (or in inflationary periods, even months ago).

There are three common measures of inflation used in the UK: the retail price index (RPI), the consumer price index (CPI), and the consumer price index including housing costs (CPIH). These are all now reaching highs we last saw in the early 1990s. Due to the rapidly rising cost of living, people’s pension savings now need to stretch much further to maintain the same lifestyle.

So, what should you do?

For every life stage, there are steps you should take now to mitigate the risk of your pension running out sooner than planned.

Saving for retirement

If you’re saving for retirement, the usual guidance still applies: contribute to your pension early and often to make the most of the tax benefits and compound returns. Pensions are one of the most tax-efficient ways to save as you receive tax relief when you contribute and can take 25% of your total savings tax-free.

Bear in mind that any cash savings you have are losing their purchasing power at a faster-than-usual rate. Investing offers the opportunity to beat inflation. However, investment growth is not guaranteed, and your investments can go down in value as well as up. Now might be a good time to check in with your financial adviser to see if your investments and pension are well-positioned to beat inflation. 

Ready to retire

If you’re ready to retire and currently choosing how to access your pension, it’s crucial to seek individual, professional advice to avoid making a mistake that could impact your finances for the rest of your life.

During market downturns, it is rarely recommended to withdraw your 25% tax-free lump sum, which could be worth considerably less than its previous high. Though each person’s finances are unique, it’s usually more sensible to access your pension flexibly and wait for the markets, and inflation, to settle.

Some people choose to buy an annuity instead of flexibly accessing their pension, as this option can offer a guaranteed income for life. If this is your preference, you may wish to look at inflation-linked annuities to ensure that your guaranteed income rises at the same rate as the cost of living. Again, you should speak to an adviser before making a final decision.

In retirement

If you are making flexible withdrawals from a defined contribution pension, it can be very concerning when the value of your investments drops. Hold your nerve and remember that pensions are long-term investments that are intended to rise and fall in the short term. A loss in value is only a true loss if you withdraw the money now, whereas, if you leave it invested, it has the chance to regain its value.

As such, try to avoid large withdrawals. Though you may need to meet rising living costs, it’s sensible to use money from other sources first, such as your state pension or cash savings (although, don’t forget to leave some cash in your emergency fund). If you have a defined benefit pension (also known as a final salary pension), these are usually inflation-linked, so will continue to provide a rising income.

You may need to review your retirement forecast and pension investment portfolio to ensure it can deliver the income you need. Speak to your financial adviser for guidance and reassurance.

Investec Wealth & Investment (UK) is a trading name of Investec Wealth & Investment Limited which is a subsidiary of Rathbones Group Plc. Investec Wealth & Investment Limited is authorised and regulated by the Financial Conduct Authority and is registered in England. Registered No. 2122340. Registered Office: 30 Gresham Street. London. EC2V 7QN.