Inflation is a real threat to pensioners. Inflation will reduce the value of your income unless you take measures to combat it. With retirement often stretching twenty to thirty years or more your income should ideally keep pace with inflation.
Most final salary schemes and the State Pension will usually build in an annual “pay rise” as measured by CPI or RPI. However, if your retirement income is generated from cash or investments, you have the dilemma of deciding how best to protect you and your family against future inflation.
With personal pensions the choice is yours. You can choose to have your pension paid at a level amount every year or you can build in an annual increase. This increase can either be a fixed amount each year of say 3% or instead you can request your income moves in line with inflation.
The downside of inflation proofing is the starting income for an increasing pension will be lower than if you choose a level income. You therefore need to weigh up the benefits of both before making your final decision and also take into account your other assets and investments.
HOW INFLATION REDUCED THE SPENDING POWER OF £1,000
It is not just your pensions you need to protect against inflation; your savings are also at risk. The table below shows how different levels of inflation can erode your income overtime.
Cash on deposit is relatively secure, offers immediate access and your capital is guaranteed up to the Sterling equivalent of €100,000 (currently fixed at £85,000) under the Financial Services Compensation Scheme. However, once you have enough saved for a rainy day it could pay to consider assets which offer higher potential returns.
| What £1,000 will be worth in real terms . . . | ||||
| Rate of Inflation | 2.5% | 5.0% | 7.5% | 10.0% |
| in 5 years | £884 | £784 | £697 | £621 |
| in 10 years | £781 | £614 | £485 | £386 |
| in 15 years | £690 | £481 | £338 | £239 |
| in 20 years | £610 | £377 | £235 | £149 |
| in 30 years | £477 | £231 | £114 | £57 |
| in 40 years | £372 | £142 | £55 | £22 |
How Inflation Erodes Your Buying Power
Click here for Step Ten: Investment Strategy
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