Beating inflation in retirement was the top concern on a pensions webinar Q&A that I hosted last week. And so it should be. Everyone needs their hard-earned nest egg to keep its value — and inflationary pressures have not gone away.
Doug Brodie, founder of retirement planning firm Chancery Lane, calls inflation “the single biggest risk” to pensions.
New figures released by the Pensions and Lifetime Savings Association show the “moderate” and “comfortable” retirement living standards, a rough guide to how much a retirement lifestyle might cost, have recorded marginal increases to £31,700 and £43,900. That is a concern for anyone who wants a retirement with decent holidays and lots of eating out.
Kevin Brown, savings specialist at Scottish Friendly, points out that the last set of inflation data showed prices still rising above the Bank of England’s 2 per cent target rate.
“In short, it is a murky outlook for the second half of 2025,” he says.
The consumer price index in the UK in April — the most recent figure published — was 3.5 per cent higher than a year before. That was the highest rate for 15 months.
At 2 per cent inflation, according to Fidelity International analysis, the purchasing power of a £1mn retirement pot would diminish to £820,000 over 10 years. A sustained rate of 4 per cent would reduce the same pot’s value to £660,000, the firm calculated.
Over a 30-year retirement span, there will be inevitable inflation spikes. Those in their 60s and older will remember the 1970s when the annual inflation rate peaked at 24 per cent.
Yet inflation is commonly misunderstood, according to Matt Conradi, deputy chief executive of Netwealth.
“Many retirees either underestimate its long-term impact or overcompensate based on recent periods of high inflation,” Conradi says. “This can lead to poor decisions.”
But, according to investment experts, there are a number of points pension savers should bear in mind that can help to protect them against the spectre of inflation.
The first is not to be confident that the “triple lock” on the state pension will protect them in their later years. The arrangement, in place since 2011, guarantees that the state pension will rise by at least 2.5 per cent annually, or by the annual inflation rate or the rise in average wages, whichever is higher.
Many experts expect the triple lock to be replaced by either a simple link to inflation or a “double-lock” to average earnings and inflation. Demographics and rising life expectancy have been steadily making the existing lock unaffordable.
Savers should also check their exposure to cash savings, which often fail to keep pace with inflation, advisers suggest. Allocations to cash may have crept up as interest rates — and therefore interest rates on savings accounts — have been higher in recent years.
Andrew Oxlade, a director at Fidelity International, says investors may have good reasons for keeping some of their wealth in cash.
But he adds: “Make sure it’s a conscious decision.”
Beyond those points, advisers recommend pension savers should seek a mixture of some guaranteed, perhaps inflation-linked, income alongside a flexible portfolio of drawdown assets designed to grow over time.
For the guaranteed part, many people buy an annuity. William Burrows, a financial adviser and founder of The Annuity Project, says payouts from an inflation-linked annuity start at about 30 to 35 per cent less than those from a level annuity. Level annuities pay out the same amount over the instrument’s lifetime.
Burrows says this difference explains why most people prefer level annuities to inflation linked.
“Generally, people value money today as more important than money in the future,” he says.
Chancery Lane’s Brodie, however, points out that if a future government changes tax rates holders of level annuities are “potentially stuffed by tax and inflation”.
People with large pensions can split their purchases between level and inflation-linked annuities. Alternatively, they can spread the purchase of a level annuity over five to 10 years.
They can stage the purchases by phasing into retirement. They can use a portion of their pension fund to buy an annuity and use the tax-free cash sum to supplement it for a few years. They can then come back a few years later, buy a top annuity and get some more tax-free cash.
However, some advisers prefer to purchase UK government bonds directly.
Brodie creates the same level of income as an annuity for his clients by purchasing a mixture of 10 different UK government bonds that mature at different times. That approach avoids depleting his clients’ capital, as an annuity instantly does. Even for investors that need the income to escalate at 3 per cent a year, Brodie says his method can work out much cheaper than buying an annuity.
Meanwhile, for the element of the pension that remains invested in drawdown, most advisers continue to advocate holding shares, despite recent periods — such a 2022 — when falling stock markets and higher inflation coincided.
Oxlade says history shows stock markets offer some protection from inflation, especially for companies that can pass on price rises to customers. However, advisers say the nature of the share exposure is crucial. They generally prefer dividend-producing shares or investment trusts.
Brodie says his research shows investment trusts perform better than dividend-producing shares.
Other than shares, infrastructure investments have traditionally shown resilience in the face of inflation.
Tideway Wealth, which offers financial advisory services, also favours higher yielding, lower volatility investments such as UK corporate bonds, now yielding about 6 per cent, and UK high-yield bonds at 7 to 8 per cent.
The verdict is less clear on gold, often considered an inflation hedge. Some experts dismiss it as an unreliable inflation hedge, or a speculative asset producing no income.
The current elevated price makes the metal a high-risk strategy, according to James Baxter, founder of Tideway Wealth.
“You are in effect betting on someone buying it back from you in the future at a higher price,” he says.
The ultimate choice for investors facing inflation, according to advisers, is between guaranteed and probable outcomes. Annuities provide a guarantee. An equity dividend and gilt strategy provides a probable solution. Brodie says that, once this is explained to clients, few choose the annuity.
Moira O’Neill is a freelance money and investment writer. Email: moira.o’[email protected], X: @MoiraONeill, Instagram @MoiraOnMoney