Inflation stays at 4% - what does it mean for your pension?

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The UK rate of inflation has remained at 4% for a second month in row – lower than some economists expected.

The main factors in the rate staying the same were higher gas and electricity prices, according to the ONS to Office of National Statistics (ONS), while housing costs also contributed to the push upwards.

By contrast furniture, household goods and food prices all eased slightly.

Susannah Streeter, Head of Money and Markets at Hargreaves Lansdown, believes that the current rate will continue to drop, echoing suggestions from the Bank of England:

“Disinflationary forces are at work in the economy, which should see further drops in the months to come, with the target of 2% within reach this spring.”

But even though inflation has fallen significantly since its peak of 11.1% in October 2022, prices are still rising at twice the Bank of England’s target – so what does that mean for your pensions and savings?

Your April State Pension rise is unaffected

The current 4% inflation rate does not affect April’s bumper State Pension increase. The 2024 rise was set last September, based on last year’s uplift in average wages by 8.5%.

As a reminder, the full basic State Pension will rise to £169.50, while the full new State Pension will hit £221.20 from April 2024.

Called the ‘triple lock’, the State Pension increases every year by the greater of: inflation (which is measured by the Consumer Prices Index), earnings growth or 2.5%, and is intended to keep things in line with the cost of living.

What does 4% inflation mean for your personal pension?

While prices aren’t rising as fast as they were, they are still heading upwards, which means the spending power of your money is reduced.

To put that into perspective, Tom Selby, Director of Public Policy at AJ Bell, says that inflation has radically changed the amount people will need to live.

“A ‘moderate’ standard of living in retirement now costs a single person £8,000 more than it did in 2022/23, according to the PLSA, with this increase driven in part by higher food, energy and motoring costs,” he says.

“[However,] it’s not just the inflation pressures on retirees that have driven this rise, with an extra £1,000 a year added to the costs of people in this group to help out family members struggling due to the cost-of-living crisis.”

James Jones-Tinsley, Self-Invested Pensions Technical Specialist at Barnett Waddingham, sounds a more positive note. He points out that if you have a sufficiently large pot saved, then you’re not going to feel the effects of inflation eating into your retirement fund for the first year or two of higher rates.

"The bigger that your pension is, the more money you have at your disposal to offset the effect of rising prices [through investment growth]. Although, where your pension provides you with the same amount each year, inflation will still reduce its real value over time," he says.

If you're still working - and perhaps even enjoying an inflation-busting pay rise – it’s a good idea to think carefully about what you do with your extra cash – with paying more into a pension a good place to start.

If you have one, contributing a percentage of your salary into a self-invested personal pension (SIPP), rather than a fixed amount or occasional contributions, can help you keep pace even if prices rocket. However, do remember that the investment might fall as well as rise in value, so you might not always get back everything you paid in.

Will my final salary scheme be affected?

Even people with gold-plated final salary (or defined benefit) pensions are not immune to inflation. Their annual index-linked rises are usually limited to a maximum of 3%-5% a year.

With inflation reaching a record 11% in 2022, many taking a final salary pension will have suffered a permanent cut in real terms in their standard of living. Thankfully, a pension increase of 4% will keep pace with the recent level of inflation.

At 3%, you’ll feel the squeeze as your income has fallen in real terms. However, trustees may have the flexibility to make discretionary increases during periods of high inflation, so it’s always worth raising the matter with your scheme if your increase is below 4% in 2024.

What about my annuity?

If you have annuity that pays a level income (one that's not linked to inflation), you may struggle as time rolls on with the yearly amount you receive.

If inflation held at 4% for a period of 10 years, the spending power of £10,000 today would fall to just £6,756, where 2% would mean it would be worth £8,203.

Some people choose annuities that rise every year to protect income against rising inflation over time. But Jones-Tinsley says these polices don’t always deliver great value:

“An annuity which increases each year is a very expensive option to buy, and if inflation remains very low for a long time, it may take several years for the increasing income amount to catch up [compared to] the income amount purchased on a ‘level’ (or non-increasing) basis”.

However, current pension rules mean annuities are no longer the only way to turn your pot into income.

New retirees can choose to buy an annuity to cover their bills but leave some pension invested in a drawdown plan. This money would then benefit from any stock market growth to help protect from inflation.

A bright note for savers

If you’ve got money in savings, the 4% inflation rate isn’t terrible news. But to ensure the spending power of your money isn’t reduced, it’s important you keep your money somewhere that’s paying an interest rate above that of inflation.

Thankfully, at the time of writing, there were still many savings accounts available that were able to offer an interest rate above 4%, although some may require you to lock your money away for a set amount of time.

But Rachel Springall, Finance Expert at Moneyfactscompare.co.uk, says it’s important not to hang around: “The savings market has felt a few rate cuts over the past couple of months, with fixed rate bonds under the spotlight. Consumers will need to act quickly to grab the top deals on offer.”