How can I inflation-proof my pension?

Q: How can I keep the value of my SIPP returns inflation-proofed for the future?

A: Many people fail to take account of the negative effect inflation can have on their savings in retirement. As the price of everyday goods and services rises, so the buying power of a fixed sum of money decreases.

This may not be particularly noticeable from one year to the next, but over longer periods of time inflation can have a marked impact on the value of your savings. An inflation rate of 3% will almost halve the buying power of a £100,000 pot over a 20-year timespan.

This stark figure is worth bearing in mind, given a woman aged 70 today, for example, has an average life expectancy of 88. So those retiring in their 60s need to make their savings last for 20-plus years. 

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So what can you do to protect your retirement savings from the pernicious effect of inflation, often known as a ‘silent bank robber’?

The first piece of advice is not to keep all your retirement savings in cash. Most deposit accounts, or cash funds, pay an interest rate that is below prevailing inflation rates, so your savings will lose value in real terms over time. Instead, look to keep at least part of your portfolio in growth assets, such as equities (stocks and shares), which have historically delivered higher returns over the longer term, helping investors keep pace with inflation.

As ever though, there is a balance to be struck, with equities likely to be more volatile. This market volatility can be more difficult to manage in retirement, as it can take longer to recover from downturns if you are taking money out of a SIPP, rather than putting more in through regular contributions.

Diversification is key here, investing in both higher-risk growth assets and less volatile funds (such as bonds and cash) to manage these various shorter- and longer-term risks.

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It is also worth thinking about inflation-proofing the income you take from a SIPP. If your money is invested, hopefully the growth on your funds will allow you to increase the income you take, year on year, to cover rising prices. Many SIPP investors will invest in income-focused sectors and funds in retirement, which might include equity income funds. These invest in a range of companies that have a good track record of increasing dividend payments each year, helping investors ensure their income keeps pace with inflation through rising distributions. There are also a range of bond funds with a focus on income.

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Alternatively, you may want to consider annuities for some of your savings — either now or for the future. Many choose to keep their SIPP fully invested in the early part of their retirement, giving them the flexibility to draw down funds as they need them. But some prefer the simplicity and security an annuity offers in the latter part of their retirement.

An annuity is guaranteed to pay a fixed income for life, regardless of how long you live. However, if this is a level payment then inflation is again an issue, as its buying power will decline as you age.

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It is possible to buy inflation-linked annuities, where the payment is linked to the Consumer Price Index (CPI), the official rate of inflation. Alternatively, you can buy fixed-rate escalating annuities, which see your income rise by a pre-set amount each year, usually 3 or 5%.

With both, though, the starting income you’ll receive will be lower than a level annuity. When buying an annuity product shop around to ensure you are getting the best rate; don’t just buy from your current pension provider.

It is probably impossible to completely mitigate inflation, particularly if it continues to remain high. However, these steps can help ensure that not all of your savings are eroded by higher prices. It is also worth remembering that the triple lock ensures that your state pension will increase by inflation, earnings, or 2.5% — whichever is higher.

The government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.co.uk or over the telephone on 0800 138 3944.

Our retirement specialists also provide free guidance to help you with your decisions. They can provide advice and help you select products too, though this will have a charge.

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Eligibility to invest in a pension and tax treatment depends on personal circumstances and all tax rules may change in the future.Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.