Headwinds rising? Inflation and your retirement


Inflation is an old enemy, now almost forgotten in many countries. But should we worry again, and what impact could this have on our pensions?

In extreme cases, inflation has been a historical nightmare. Germany faced ruinous hyperinflation right after World War I as it printed money to pay off war debts and expensive repairs. A loaf of bread that cost 160 marks in 1922 soared to 200 billion marks the following year. People were burning banknotes for warmth, their change having no value.

No one is suggesting that we will see a repeat of this phenomenon today in OECD countries, including the UK. However, inflation has increased. Prices in the United States rose 5.3% in August 2021 from August 2020. Average UK house prices rose 8% during the year through July 2021, according to the Office for National Statistics, up from 13.1% in June 2021. This is the highest annual growth. rate the UK has experienced since November 2004.

Inflation is the moth that eats away at your savings and income

The consumer price index (including owner-occupied housing costs) is also of concern, increasing 3% in August 2021, up from 2.1% in 12 months to July. This was six times the 0.5% figure from August 2020, with the cost of fuel, used cars and food all soaring during 2021.

But what is the reality of this inflation figure? The measures are based on consumption baskets of goods and services, and statisticians have not caught up with our spending changes induced by the pandemic: less on plane tickets, cafes / sandwich bars and travel, more on tech, gadgets and DIY. In addition, the expense profiles of a universal credit applicant and an affluent commuter are difficult to average.

Silver wall

But there are strong headwinds. As the pandemic subsides, a wall of money waits to be spent, with UK savers setting aside £ 220bn since February 2020. This cash surplus, combined with supply shortages, is pushing prices up. Indeed, the Bank of England predicts that inflation will reach 4% by the end of the year, with pressures coming from the phasing out of reduced VAT in hotels and hotels on September 30, when it goes from 5% to 12.5% ​​until March 31. A massive increase in Ofgem’s gas price cap on October 1, up £ 139, is also in the works: this will affect 9 million customers following record increases in gas prices.

The Bank of England, however, believes inflation is a transitional blow, easing in 2022. Still, concerns persist. Indeed, some believe the quantitative easing program – whereby the Bank of England bought bonds worth £ 895 billion in response to the financial crisis in 2009 – has already triggered a bubble. active in real estate and stocks.

The pandemic was an even bigger economic shock. Alistair McQueen, head of savings and retirement at Aviva, notes that “UK GDP fell by a quarter in the first months of 2020. In response, the UK government spent an additional £ 350 billion. This is in addition to ‘UK government spending of £ 850 billion a year before the pandemic’.

Indeed, public debt has peaked in peacetime of £ 2.2bn in the past 18 months, or the equivalent of £ 80,000 for every UK household. One good thing is that borrowing has never been cheaper, thanks to low inflation and low interest rates.

But eventually the debts have to be paid off, or Britain could become another Weimar Republic. If the inflation wind blows again next year, interest rates will have to rise.

Manage the risk of inflation

Most defined benefit pension plans manage inflation risk through hedging, using a liability-driven investment strategy. Some programs also use indirect inflation hedging assets such as infrastructure and real estate investments that have some link to inflation.

“If the fear of current inflation increases, there will probably be more demand for portfolio protection in these forms,” ​​predicts Tappan Datta, head of asset allocation at Aon, retirement consultants. “Even commodities may at this point become attractive again, which pension funds tend to avoid due to their relatively low and highly volatile return path.”

What about retirement savers?

Saving in cash is ill-suited to finance retirement. Most accounts only pay 0.1% interest per year, or 10p on £ 100. According to Moneyfacts, no standard savings account can exceed the current inflation rate of 2.1%. Last year, 91 deals could beat the inflation rate by 1% at the time.

Ian Burns, director and actuary of pension consultancy Buck, advises workers to “contribute a percentage of salary rather than a fixed amount or one-time contribution when fighting inflation in pension fund savings . Your pension contributions will then increase according to the evolution of salaries, which will probably be higher than inflation throughout your career ”.

Stocks are generally seen as a natural investment to generate real returns against inflation, he says. The dividends provided by stocks can also be attractive and increase with inflation, with the dividend yield currently being around 3.4% on the FTSE 100.

“Investors must be willing and able to invest for the long term (10 to 15 years or more) and must also be aware of market prices at the time of investment,” Burns said. “Investing a regular amount each month is very different from investing a large lump sum. ”

For retirees

Retirees should not leave too much money in the bank beyond their needs for two or three years. This is because inflation can wreak havoc on household budgets, especially those of private sector workers who rarely have indexed defined benefit plans. Anyone lucky enough to have such a pension should generally see it increase each year, broadly in line with inflation.

For the rest, “inflation is the moth that eats away at your savings and your income,” explains Andrew Tully, technical director of Canada Life. For the nearly 7 million people living on a fixed income in retirement, such as a level annuity, he warns that inflation of 3% will halve purchasing power in just 20 years.

Tully advises using “some form of equity investing as part of a balanced portfolio. Using a combination of levies and annuities can give people the ability to bank guaranteed income to pay the bills, while still leaving money invested to pay for life’s little luxuries and help themselves. protect against inflation.

Finally, one of the bulwarks against inflation is the state pension, the basis of people’s retirement income. This increases by “the triple lock” – the higher of inflation, income and 2.5% – and at least keeps pace with inflation. But there is no guarantee. McQueen warns: “Rising prices and wage inflation could add billions of pounds to the cost of the state pension. This forced the government to step back a year from its clear commitment to maintain the triple lockdown. “

Be prepared for the gusts.


About Rodney Fletcher

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