How to inflation-proof your retirement pot

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How to inflation-proof your retirement pot

People can make all sorts of plans for their pension pots but often forget about inflation. 

According to Ian Browne, pensions specialist at Quilter, inflation is the ‘forgotten risk’ for pension savers, and he has warned this factor can significantly derail retirement plans.

He said: “Inflation is a difficult beast to tame and may take multiple approaches to ensure you don’t run out of money in retirement."

FTAdviser In Focus caught up with Browne to ask him whether people were starting to become aware of the potential damage that inflation can do to the spending power of their pension pots post-Covid.

FTAdviser: Are people starting to wake up to inflation risk?

Ian Browne: While headline inflation figures remain at subdued levels, many investors are beginning to worry about price rises becoming a real possibility in recent months as the economy opens up.

Treasury forecasts expect the CPI rate to climb to 2 per cent for 2021, up from its current level of 0.7 per cent in January 2021.

Cash is no longer the king it once was for retirees.

While 2 per cent remains the Bank of England’s target inflation rate, the increase in consumer demand and spending, along with incredibly loose monetary policy, means many investors are concerned this could result in a prolonged inflationary environment.

FTA: What sort of effect can it have on a pension pot?

IB: Inflation can have a devastating impact on a retirement pot and could seriously change your retirement plans at very short notice. It is often the forgotten risk that can hide in plain sight.

With inflation creeping up, people won’t necessarily see prices rise so obviously and as such won’t see the impact this is having on their spending power.

At just 2.5 per cent inflation, you would lose nearly half of your purchasing power over 25 years if your money is held in cash. With interest rates and savings accounts currently failing consumers, retirees are at increased risk from inflation.

So while the state pension will, at the very least, always keep up with inflation through the triple lock, your private savings will not unless you do something about it.

FTA: What sort of action can people take to protect their portfolios?

IB: Firstly, get your investments right. If you have a long-term time horizon then you want to be considering if your attitude to risk is high enough.

Equities give you the best opportunity to outperform inflation over the long-term and have been shown to outperform every other asset class over the long-term.

Review the investments your pensions are in and if you have a time horizon of ten years or more, check you haven’t been invested in a pension scheme’s default fund. Often these will have a mix of assets that may not be appropriate for the amount of risk you may be able to take.

As you reach retirement, consider keeping money invested in the stock market for as long as possible. This is a higher risk option, but with ‘safer’ asset classes offering little to no income it might be sensible to keep the money invested and rely on a cash buffer to cover your daily outgoings.

FTA: When it comes to 'safer' asset classes, this may well include cash. What's your take on cash assets?

IB: Don't sit on cash. The amount of excess savings that have been built up during the pandemic is staggering. But with cash providing little to no real return, having too much could have a significant drag on your retirement plans.

We all need a level of cash for day to day spending and emergencies but having more than that will cause problems with inflation. Cash is no longer the king it once was for retirees.

FTA: Are annuities a thing of the past?

IB: It used to be that when you started retirement you would cash in your pension pot and buy an annuity.

The popularity of these products has since plummeted with the advent of pension freedoms and with rock bottom interest rates, they are unlikely to provide value for money unless you live to a very old age.

Consider keeping money invested in the stock market for as long as possible.

However, if you want the security of a guaranteed income, with an inflation link, then they are definitely worth considering to give you that peace of mind.

It’s never too late to buy an annuity so it’s always worth checking the latest deals throughout your retirement. The older the you are or if your health has deteriorated, the better the deal could be. You should remember, though, that once you buy an annuity there is no going back.

FTA: As Covid-19 hit, we read of people delaying their retirement. Is this a potential part of inflation-proofing?

IB: If you are able to then you might want to consider delaying touching your pension, particularly if you have other sources of income or wealth.

Salaries tend to rise in line with inflation, so this will give you an opportunity to continue to contribute to your pension, take advantage of the tax relief available and invest it to give you above inflation returns depending on your time horizon.

Furthermore, as you reach the later stages of working life, spending on things such as mortgages begin to decline, so make use of any additional savings by stashing it away in a pension. It is effectively the best savings account on the market for the over 50s and should be the last savings you should withdraw from.