Why increasing pension contributions with inflation could help you achieve your dream retirement

Inflation has never been far from the headlines in the last few years. A combination of the Covid-19 pandemic and the war in Ukraine led to a spike in living costs and uncharacteristically high levels of inflation.

In response, the Bank of England (BoE) raised interest rates to control inflation, and this caused an increase in borrowing costs for many people.

As a result, most of us have noticed our outgoings rise and stories about financial hardship dominate the news cycle. Much of this discussion about inflation focuses on the short-term effects such as higher grocery bills or rising mortgage payments.

Yet, it’s equally important to consider how inflation could affect your pension savings in the future. You may need to account for the effects of inflation when planning your retirement.

Read on to learn how inflation affects your pensions and why increasing your pension contributions could benefit you.

Inflation could erode the value of your pensions over time

Inflation describes the increasing cost of goods and services over time. For example, if inflation is 2%, the same goods that cost you £1,000 a year ago would cost you £1,020 now. As a result, your £1,000 is worth slightly less in real terms because you can’t buy as much with it.

This effect could erode the value of your pensions over time if they don’t grow in line with inflation.

For example, the BoE inflation calculator shows that goods and services costing £10,000 in 2004 would now cost £17,381.02 in March 2024.

If you created a retirement budget in 2004 and determined that you’d need around £10,000 a year to cover your living expenses, you might assume that a pension pot of £200,000 could last you around 20 years.

Yet, by 2024, inflation would mean that the same lifestyle now costs you significantly more than £10,000 a year. As such, your £200,000 might not last anywhere near as long as 20 years unless you made sacrifices to your lifestyle.

That’s why it’s important that your pension savings grow in line with inflation so you can still afford to maintain your desired lifestyle over time.

Unfortunately, high inflation could dampen the growth that you achieve on your pension. For instance, Moneyfacts reports that the average pension fund growth in 2021 was 9.5%. However, inflation averaged 2.59%, meaning the real-terms growth was 6.91%.

As such, you can see the importance of factoring inflation in when making calculations about your retirement savings and how much your pension is likely to grow.

Additionally, if your pension growth is lower than inflation, your savings could lose value in real terms and you might have to make sacrifices to your lifestyle in retirement.

Fortunately, by increasing your contributions in line with inflation, you may be able to ensure that you can achieve your dream lifestyle in retirement.

Your workplace pension contributions may rise alongside your wages, but there are no guarantees

Typically, your workplace pension contributions are calculated as a percentage of your earnings. As a result, if you receive a pay rise, the amount you pay into your pension will also rise at the same pace.

This is good news if you receive a pay increase that beats inflation. However, this isn’t always the case.

For example, according to Statista, average wages (excluding bonuses) grew by 6.1% in October 2022, yet inflation reached a 40-year peak of 11.1%. In fact, between February 2022 and May 2023, inflation was consistently higher than wage growth.

While inflation was uncharacteristically high recently, and the figures have since fallen, the situation demonstrates how your wages could fail to keep pace with inflation. This might mean that your pension contributions aren’t high enough to meet your savings goal and achieve your dream lifestyle when you account for inflation.

It’s also important to note that you’re not guaranteed a pay increase, even if average wages are rising. Additionally, contributions to private pensions won’t normally automatically change when your earnings increase.

That’s why it’s important to pay close attention to your pension and consider increasing your contributions to keep pace with inflation.

Despite this, the Institute of Fiscal Studies (IFS) reports that less than 1 in 100 private sector employees actively increase their pension contributions when they receive a 10% pay increase.

Increasing your contributions with inflation could make you £124,000 better off in retirement

Increasing your pension contributions with inflation could make a significant difference to your pension pot over time. Ultimately, this could mean that you’re more likely to achieve your dream lifestyle in retirement.

Data reported by MoneyAge shows that somebody paying £250 a month into their pension could grow their pot by £124,000 if they increase their contributions by 2%.

The same is true of your other investments. An investor contributing £200 a month to an investment account outside of their pension could be almost £100,000 better off after 40 years if they increased their payments by 2%.

Conversely, if you keep your payments to pensions and investments the same, inflation could mean that the amount you contribute falls in real terms.

Naturally, you can’t control the growth of your pensions and other investments, and they could lose value, but you do have control over how much you contribute. That’s why it may be beneficial to regularly review and increase your pension contributions if you can afford to.

Get in touch

We can help you calculate what difference increasing your pension contributions could make to your retirement savings in the future.

Please give us a call on 01276 855717 or email info@braywealth.com today.

Please note

This article is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.

Workplace pensions are regulated by The Pension Regulator.

The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.

Approved by the Openwork Partnership on 07/05/2024