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Inflation explained

How it affects the buying power of your pension

We’re all too used to the unwelcome effect of inflation on prices. Even if rates of inflation are relatively low, over a long term – say ten years or more, they can have a major impact on prices.

Prices and savings
Your retirement income

With inflation at only 3% a year for example, a pint of beer that costs £2.50 today would cost more than double in 25 years.

	Cost today	In 10 years time	In 25 years time	In 40 years time
Holiday	£2,000	£2,714.04	£4,290.39	£6,782.29
Pint of beer	£2.50	£3.39	£5.36	£8.48
Car	£10,000	£13,570.21	£21,451.94	£33,911.47

The figures used here are for illustration only. Rates of inflation could be greater or less than 3%.

What this means for you

When you start out saving for your retirement, you’ll want to make pension contributions that are realistic compared to your earnings. But if you never review your contributions, they’ll gradually go ‘out of date’ and could be completely inadequate when you come to retire.

If you make your retirement plans based on your income today, and today’s prices, you’ll need to review your plans on a regular basis. This will help you ensure that your contributions remain realistic, compared to prices and your earnings.

The effect of inflation on your pension

Inflation doesn’t stop when you retire. As the years go by, it could have an increasingly damaging impact on the purchasing power of your retirement income.

With inflation at 3% for example, in ten years time, the value of £1,000 worth of pension will fall to around £740 in today’s terms. After 20 years, it will be worth around £540.

The figures used here are for illustration only. Rates of inflation could be greater or less than 3%.

What you can do

Ideally, you should build an element of inflation proofing into your retirement planning. Put simply, you need to save more than you might think. If you save more, you’ll potentially have more in your pension pot when you retire and be better able to buy an annuity that gradually increases over time.

Increasing annuities cost more than level payment annuities. By making sure your retirement savings remain realistic, you’ll have a better chance of beating inflation.