Articles - Higher inflation makes pensions work harder


There can be very few of us who are not beginning to feel the effect of rising inflation on our daily spending. It might be small changes – like this week, when I noticed the £10-meal-deal in my local supermarket is now the £12-meal-deal. Or bigger things, like the price of petrol seemingly to be more than it was before the cut in duty announced in the Budget. When price rises are this noticeable, you do not need the official ‘basket of goods’ figure to tell you that inflation is a problem and that household budgets are stretched.

 By Dale Critchley, Workplace Policy Manager, Aviva
 
 We have not seen any difference in behaviour across our workplace pension members, but there is, of course, a possibility that individuals might begin to consider prioritising daily spending over saving for retirement. It will be a unique situation for everyone, but for some, that might seem like the only feasible course of action.

 Unfortunately, higher inflation means pension funds need to work harder to deliver the same spending power in retirement.

 Reducing pension contributions or taking benefits makes it harder to deliver the same standard of living once people give up work.

 But it is tough to balance the urgent and immediate needs caused by the current cost-of-living increase with the longer-term financial needs.

 Work done by the Institute for Fiscal Studies, published in 2020, points to the power of inertia in maintaining workplace pension contributions . Even when people’s finances are under pressure, the study found very little change in workplace pension participation levels. Almost 9 in 10 (89%) of the least financially secure - measured as people who were behind on two bills - were members of their workplace pension, compared to 92% of the most financially secure – measured as those up-to-date on all bills.

 These figures suggest that we should not expect to see a widespread exodus from pension saving. However, it is more important than ever that those who might be struggling with their daily finances are aware of their options.

 For those who are retired, or are coming up to retirement, inflation may be something they are thinking about more now than in the past. Many retirees who take out an annuity opt for an income that does not increase, to maximise their initial level of retirement income. The Financial Reporting Council’s proposals for statutory money purchase illustrations, which will also populate Pension Dashboards, are that a flat annuity income should be assumed.

 Those who want to protect themselves against even relatively modest levels of inflation may be surprised by the cost of providing for an income that keeps pace with inflation, brought about by the effect of compounding over time. Those that choose a flat income should also be aware of the same discounting effect that inflation has on their purchasing power.

 One of the major causes of the current inflationary pressure is said to be the price of fossil fuels, which was initially driven by the economic recovery from the pandemic and then accelerated by the Ukraine crisis. It might seem that pensions have no role to play, but these issues reflect a reliance on an energy source that is finite – both in absolute terms, and by commitments to reduce its impact by 2050.

 As a response, we have seen the UK government considering accelerated investment in nuclear energy to diversify and secure future energy needs. At the same time, there have been calls for a windfall tax to peg back the profits of petroleum companies.

 These interventions are possible portents of the kind of actions we could see employed to tackle climate change. They illustrate the need for pension schemes to manage Environmental, Social and Governance (ESG) risks.

 Pension funds can play a big role in encouraging companies which are ‘transitioning’. For example, companies which once set out as purely oil extraction firms have over recent years chosen to see themselves as energy companies - as opposed to oil companies - and are now investing heavily in renewables. Which is great news. It means pension funds are having an impact on reducing carbon footprint and are also focussing investment in areas which are part of the solution.
  

  

            

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