Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.
Over-50s in the UK are more worried about inflation eating away the value of their retirement savings than about market volatility or policy changes, new Fidelity research has found.1
Almost one in three (29%) of over-50s think the biggest risk that could prevent them reaching their retirement goals is inflation. Around a quarter (27%) see regulatory shifts, including changes to tax or pensions, as the biggest risk, compared with just 14% who went for market volatility.
The findings might seem surprising when you consider growing concerns about an impending stock market crash and potential for sweeping tax changes in the upcoming Autumn Budget.
Here we look at whether people are right to be concerned and how to inflation-proof your retirement.
Why inflation is a real threat to UK retirement savings
The Bank of England’s target is to keep inflation at 2%. However, in recent months price rises have overshot this. In the latest numbers, inflation has remained stubborn at 3.8% - almost double the target.
Our own calculations show that, even small increases in inflation like this, can make an enormous impact on people’s retirement plans.
In a world of 2% inflation, a 55-year-old woman earning £3,500 a month after tax with £300,000 in her pension could retire at age 67 and expect her savings to last to around age 95.
We assume:
- 15% of her pre-tax salary goes into her pension each year until retirement
- She initially takes an income of two-thirds of her final salary. This rises through retirement in line with inflation
- She receives a full state pension at 67
- She achieves returns on her investments of 5% per year after fees
However, in a world of 3.8% inflation, the situation is quite different.
Assuming no other changes in her financial situation, in the higher inflation environment, the same 55-year-old would find her pension pot runs dry by age 89 - six years earlier.
The average life expectancy for a 55-year-old woman currently is 87 and she has a one in four chance of living to 95.2This means that, with inflation at 3.8%, there’s a high risk she would outlive her savings.
How to inflation-proof your retirement
Keep some growth assets
It’s common to derisk your pension as you near retirement by moving from stocks into less volatile assets like bonds and cash.
However, being too cautious can backfire. Many retirees will still have another 30 years or more to live after they stop work and, over such long periods, holding low-return assets that do not keep pace with inflation can ravage the value of your savings.
Our own Fidelity research shows that, in every rolling 20-year period since 1988, the returns from UK stocks have beaten inflation, whereas cash returns failed to do so in a quarter of those cases.
Of course, going all in on stocks would be highly risky for a retiree. Having a cash buffer of, say, two to three years’ worth of spending means you can avoid having to sell investments during market dips if you suddenly need to call upon the money.
Our guide to six ‘Steady Eddie’ funds could be a good place to start when considering investment options that aim to grow your pot steadily through retirement: 6 'Steady Eddies' for a stress-free retirement
Buy an escalating or inflation-linked annuity
Inflation-linked annuities are arguably the ultimate hedge against rising prices. You can use your pension money to purchase one of these policies, which agrees to pay you a set amount of money for life, with that amount rising each year with inflation.
As you can see from the chart below, rates for annuities have become attractive recently, buoyed by rising gilt yields. However, it’s important to note that the rates you get for an inflation-linked annuity will usually be worse than for a standard, level annuity which pays the same amount each year regardless of how prices have moved.
Alternatively, you could buy a fixed escalation annuity. With this type of policy, the amount you receive rises each year but by a fixed amount, say 2.5%, rather than by inflation. Rates for these types of annuities may be better than for an inflation-linked annuity, as there is less uncertainty for the policy provider.
Some retirees prefer not to buy an annuity because they want to continue benefitting from any future stock market growth and want to retain flexible access to their money.
In this case, a blended approach might work. You could use part of your pot to buy an inflation-linked annuity and leave the rest in drawdown. This could give both security over your income and flexible access to the rest of your pot.
For more information about how to blend annuities and drawdown for a “best of both worlds” approach, read our article here: The benefits of a blended approach to annuities and drawdown
Consider real or inflation-linked assets
You might also consider investing in specific types of assets that could outperform in a high inflation environment.
Property, for example, can do well in times of inflation if rents and values are able to track inflation. You can get access by buying property directly or via a property investment fund, such as a Real Estate Investment Trust (REIT).
Commodity funds might be able to offer some inflation protection, too. Commodities, such as oil or metals like gold, tend to rise in price when inflation increases - although this isn’t always the case.
Remember that these are all specialist investments which come with their own set of risks, so you should do careful research before investing.
It’s also important not to put all your eggs in one basket. A well-diversified portfolio, spanning different asset classes, sectors, and geographies, can help smooth returns and reduce risk over time.
For more information about which asset classes and geographies have been best at beating inflation, read our article here: How to ensure your savings beat inflation in 3 charts
Plan how and when you take your income
If you can delay drawing your pension - for example, by working a few years longer, this should help to limit the impact of high inflation on your retirement pot.
Working for longer means you’re more likely to enjoy more years of wage growth that keeps pace with, or beats, inflation. This means more money in your pension when you start to draw from it, more time for that money to grow, and fewer years of having to draw down on your savings.
Remember that the state pension rises with inflation, thanks to the triple lock, so that ensures at least part of your income is protected from rising prices.
Review your plan regularly
Inflation can move unpredictably from year to year, so it is important to review your financial plan regularly to ensure it is still appropriate.
For example, if you are withdrawing, say, 4% from your pension, rising by inflation each year, and there is a sudden severe spike in prices, you may want to review whether it is still sensible to increase your withdrawal with inflation that year or try to cut back your spending instead.
Income in retirement is a very complex area of financial planning. 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.org.uk or over the telephone on 0800 138 3944.
If you’re unsure of anything, it would be worth speaking to a qualified financial adviser. If you have over £100k invested (this includes your pension) our financial advisory service can help. The initial conversation with a Fidelity adviser is free and there’s no obligation, it’s simply a chat to see if financial advice might be right for you.
See our current offers to help make your money go further
- Read: The silent retirement risk we all ignore - and how to manage it
- Read: Budget or not, income tax is rising - but you can act
- Read: What can we expect in the Autumn Budget
Sources:
1 The findings are from Fidelity's report The longevity revolution: Preparing for a new reality, in partnership with the National Innovation Centre for Ageing (NICA). It was based on a global survey of 11,800 people aged 50+ - of which 1,000 were based in the UK.
2 Life expectancy calculator - Office for National Statistics
Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. The shares in the investment trusts are listed on the London Stock Exchange and their price is affected by supply and demand. The investment trust can gain additional exposure to the market, known as gearing, potentially increasing volatility. There is no guarantee that the investment objective of any Index Tracking Sub-Fund will be achieved. The performance of the sub-fund may not match the performance of the index it tracks due to factors including, but not limited to, the investment strategy used, fees and expenses and taxes. Eligibility to invest in an ISA 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). 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.
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