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.
Some retirees worry endlessly about the potential impact of a stock market crash on their nest egg. Yet, in some cases, it’s the slow burn of inflation – even when it’s only marginally higher than expected – that can do the most damage.
As our analysis below shows, the difference between inflation of 2.5% a year and 3.5% a year could cause someone’s retirement savings to run out six years earlier.
Here we look at how rising prices can eat away at your pension pot and outline some of the ways 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, it has failed to achieve this for the past two years: the last time the Consumer Price Index (CPI) ticked that low was June 2024.
In the latest numbers, inflation edged up to 3.5% in September, up from 3.1% in August.
Our calculations show that even relatively small increases in inflation can have an enormous impact on people’s retirement plans.
We compared the impact of inflation at its current rate of 3.5% with a lower rate of 2.5% – the standard assumption used in our retirement cash flow modelling.
In a world of 2.5% inflation, a retired 65-year-old with £300,000 in their pension could spend £25,000 per year and potentially not run their personal savings dry until age 92.
We assume:
- They receive a full State Pension from their State Pension Age
- They achieve average investment returns of 6.06% per year before investment fees of 0.41%
- Their spending increases with inflation
However, in a world of 3.5% inflation, the situation is quite different.
Assuming no other changes in their financial situation, in the higher inflation environment, the same 65-year-old could find their pension pot runs dry by age 86 - six years earlier.
The average life expectancy for a 65-year-old woman currently is 87 while for a man of the same age it’s 85.1 The chances of reaching age 90 if you’re already 65 are also relatively high: 46% for a woman and 34% for a man.
This means that, with inflation at 3.5%, there’s a high risk our 65-year-old could outlive their savings.
How to inflation-proof your retirement
Buy an escalating or inflation-linked annuity
Inflation-linked annuities are one way to protect your retirement income against rising prices. You can use your pension money to buy one of these policies, which pays you an income for life that rises each year in line with a specified measure of inflation, such as the Retail Prices Index (RPI).
Rates for annuities have become more attractive recently, buoyed by rising gilt yields. However, inflation-linked annuities typically offer a lower starting income than standard, level annuities, which pay the same amount each year regardless of inflation.
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 3%, rather than by inflation. These annuities may offer a higher starting income than inflation-linked alternatives, because the provider knows exactly how much the payments will increase by each year.
You can use the government's Money Helper annuity comparison tool to get a sense of the rates currently available. It suggests that a 65-year-old in good health may be able to swap their £300,000 pension pot for a lifetime annuity paying £1,457 a month (or £17,484 a year) – with the income increasing annually with RPI. This is for a single life annuity with no death benefits.
If that same 65-year-old instead wanted an annuity where the income increased by a fixed 3% each year, they may be able to purchase a policy paying £1,603 a month (a little over £19,000 a year) with their savings.
Annuity rates are completely individual and based on factors such as your age, health and the economic conditions at the time, therefore these numbers are indicative rather than guarantees.
- Get £250 to £2,500 cashback when you apply to transfer or add a lump sum into our SIPP. Minimum value exclusions, T&Cs apply - offer ends on 9 November 2026.
Keep some growth assets
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.
It’s common to derisk your pension as you near retirement by moving from stocks into 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 too many low-return assets that do not keep pace with inflation can ravage the value of your savings.
Of course, going all in on stocks would be highly risky for a retiree. Many will hold a mix of stocks and bonds alongside a cash buffer to cover some of their near-term spending needs. This can help them avoid having to sell investments during market dips. The key thing is to make sure you have the right balance between reducing unnecessary risk and ensuring your savings keep pace with rising prices over time.
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
Remember: it doesn’t need to be an either/or decision between an annuity and drawdown. You could use part of your pot to buy an inflation-linked annuity and leave the rest in drawdown. This could provide security over part of your retirement income while allowing you to retain flexible access to the rest of your pot.
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 offer some protection against inflation if rents rise alongside prices. However, property values can also fall, particularly when borrowing costs increase. You can get access by buying property directly or via a property investment fund, such as a Real Estate Investment Trust (REIT).
Commodities, such as oil and metals like gold, can sometimes perform well during periods of high inflation.
However, their prices can be volatile and this isn’t always the case.
Another option is index-linked gilts – government bonds where the interest payments and repayment value are adjusted in line with inflation. However, their market prices can fluctuate, particularly when interest rates change, so they aren't risk-free if you need to sell before maturity.
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.
Plan how and when you take your income
If you can delay drawing your pension – for example, by working a few years longer – this could help limit the impact of inflation on your retirement savings.
Working for longer gives you the potential to benefit from more years of wage growth that ideally 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 also offers some protection against inflation. Under the triple lock, the basic and full new State Pension rise each year by the highest of inflation, average earnings growth or 2.5%. The government plans to adjust this system from April 2030, but the State Pension will still rise by at least inflation or 2.5% each year.
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.
Imagine you start retirement by withdrawing 4% of your pension pot each year, increasing the cash amount you take in line with inflation. If there’s a sudden severe spike in prices, you may want to review whether it’s 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.
- Read: How to trace old pensions
- Read: Am I saving enough? This one graph will tell you
- Read: I'm 53. How do I know when to retire?
Sources:
1 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. 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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