The effect of inflation on savings, pensions & defined benefit schemes

According to a recent Economics Experts Survey (EES), the annual inflation rate in 2022 is forecast to hit 7.7%, about 5% higher than the rate reported by the World Bank between 2010 and 2019. As the rate of inflation is increasing globally we wanted to highlight how this might affect your savings.

What does inflation mean? 

In simple terms, inflation describes the change in the value of a currency. When looking at a nationwide scale, it’s the Office of National Statistics’s responsibility to determine the latest inflation rates. 

How is inflation calculated?

To understand how they calculate inflation rates, you need to visualise a shopping basket of up to 700 items (including goods and services) which are charted to see if there has been an increase or decrease in the price over time. This calculation is called the Consumer Price Index, or CPI for short.

Why does it matter?

Inflation affects everyone, especially those who are saving money. For example – a person may save up money to buy a new car one year, but due to the increase in inflation, that person may no longer have enough funds to make that purchase as inflation has taken the cost of the car out of their reach. Inflation causes money to erode in value even though the actual amount hasn’t changed, but what will have changed is what that amount is worth in the market. Your purchasing power decreases as your money loses some of its value. 

Therefore it’s easy to see how a significant change in inflation could impact a person’s decision concerning their pension. If you are currently in pre-retirement and inflation is at an unusually high level, it might be a smart move to place any funds possible into a pension pot where it has the opportunity to grow. Without doing this, your money could potentially decrease in value over time if left unattended.

By adding money to a pension scheme your capital could grow at a rate similar to or higher than inflation, protecting you from its impact and ultimately giving you a better financial return. Pension schemes can be a barrier to the adverse effects of inflation, but there is no guarantee that a pension scheme will keep up with inflation, especially if the rise is significant.

Thankfully, even if there is high inflation, in the vast majority of cases, this is likely to be a short-term rise and therefore unlikely to affect a person’s long-term finances. Growth could look disappointing for a period of time, however, after inflation settles back down to a more normal level, your financial health could be restored.

Inflation and defined benefit schemes

Firstly, let’s go over the basics of a defined benefit pension. If a person is due to receive, or if they have already received, an income when in retirement from a defined benefit (which is a final salary pension scheme), this benefit will be a secured and protected amount. This is based on a person’s final salary amount and the time this person has been a part of this scheme.

Defined benefit pensions are less commonplace than they were and usually have a lot of value because they give retirees what is known as ‘gold-plated’ income while they are in retirement. As defined benefit pensions give retirees safeguards from inflation since the amount the person receives should increase alongside inflation. 

Of course, each person’s specific arrangement with their employer will differ depending on their scheme. However, legally, all defined benefit pension schemes have to hand over a minimum amount to members. This is why defined benefit schemes are so sought after, as a person should know the exact amount they will be getting as their income before retirement.

So if a person is collecting income from a defined benefit pension scheme, the assumption would be that this person does not need to care about the level of inflation, as the amount that the person receives would theoretically rise along with the level of inflation. 

Furthermore, the guarantee to boost a person’s pension alongside inflation levels may be capped up to a particular limit if the person receiving their defined benefits from an employer is in the private sector. This cap usually is around 5%, and if the inflation level goes above this limit, it might not match this rise in inflation. On the other hand, public sector benefits usually increase at the same rate as inflation and are not beholden to a cap. 

If you are in a defined benefit pension, and are looking to transfer your pension to a new country of residence, then you can read about how to do that on this page of our website – 

https://www.brite-advisors.com/pensionguides/defined-benefit-pension-transfers/

What to do next?

Right now, inflation looks to be rising. Therefore it’s the correct time to look at your finances to see how inflation will affect your pension plans. At Brite Advisors, we will help to ensure you get the best financial advice possible concerning your pension, whether it’s a defined benefit pension or any other type of pension to help you deal with inflation.

Contact us here: https://www.brite-advisors.com/contact/

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