Ensure your pension beats inflation
It rose by a massive half a percentage point from 2.5% in March to 3% in April. And comments yesterday from Bank of England Governor Mervyn King suggested that it would rise further this year.
Over the course of a working lifetime, inflation can have a detrimental impact upon retirement savings. Every year a pension contribution falls in value in real terms, unless it is increased.
For example, if inflation is 4% a year, after 30 years, a £300 monthly contribution ultimately equates to a £92 contribution. For members of workplace pensions, contributions rise with their salary increase each year but those who make their own private provisions could find themselves rapidly left behind if they fail to up their contributions.
Laith Khalaf, pensions analyst at Hargreaves Lansdown says: 'As people are living longer inflation becomes more of an issue; it has more time to do its damage. Pensioners need to take steps to make sure their income is not threatened, unfortunately few are.’
But there are steps you can take to safeguard your pension from inflation - we explain how.
Invest in equities
Up until around a decade prior to retirement your portfolio should be invested heavily, preferably 100%, in equities.
While equity investments are of course more volatile than bonds or cash it is worth remembering that over the past 50 years equities have returned an average annual real return of 7.2%, while gilts and cash have delivered just 2.4% and 2% respectively.
Increase your pension contributions
By not increasing your contributions, inflation will erode your savings over the long term. Assuming 7% annual fund growth and taking into account a 1.5% annual management charge, if you saved just £300 every month for 30 years, your pension pot would be worth just £81,552.
But if you increased your contributions by 4%, every year over the 30-year term your pension would be worth £130,928. Even if you only upped your contribution every five years it would still leave you with a pension of £121,365.
You can increase your pension contributions by writing to your provider each year asking for your direct debit to be increased, or alternatively you can pay in an additional lump sum every year.
What about annuities?
Annuities, like inflation, are a hot topic right now and savers need to ensure that they shop around. This week the City watchdog, the Financial Services Authority (FSA) slammed insurers for failing to properly advertise a saver’s right to shop around for the best annuity - the ‘open market option’.
The regulator found that 40% of firms were not doing enough to make their customers aware of this. It also found a gap of some 20% between the worst and best annuity rates available and that around two-thirds of retirees end up buying an annuity with their existing pension firm, even if it is a poor deal.
When it comes to purchasing an annuity, inflation becomes even more of a concern: some estimates have even put pensioner inflation as high as 9% a year.