Check out the best ways to beat inflation

Published by Rachel Lacey on 28 July 2016.
Last updated on 28 July 2016

Rising inflation

Inflation is a little bit like getting old or putting on weight. You don’t notice its effects on a daily basis, but as the years go by you become more aware of the grey hairs or notice your old clothes don’t fit any more.

So while you might be happy that you have enough money to live on when you first retire, if you haven’t factored the rising cost of living into your plans, as the years go by you may find you have less and less spare cash and, in a worst case scenario, find you struggle to pay your bills.

Figures showing how quickly inflation can erode your savings make for stressful reading, and research from Retirement Advantage shows that money and the rising costs of living is among the top three concerns for the over-50s – up there with health problems and losing a partner.

Thankfully – for our bank balances at least – we are currently in an era of low inflation. In January 2016, inflation was at 0.2% and it has been below 0.5% for the past year, while the Bank of England’s latest quarterly inflation report states it expects inflation to remain below 1% for the rest of 2016.


Alistair McQueen, retirement and savings manager at Aviva, says: “The economy is in the doldrums with low inflation, low interest rates and low growth. There is virtually no inflation today – in other words, there is little increase in the average prices of goods. This has been driven in part by low global economic growth, falling oil prices, and a strong pound making imports cheaper.”

But that’s not to say inflation will always be low. While low inflation feels great when you’ve got a budget to stick to, a fridge to stock and a car to fill up with fuel, looking at the bigger economic picture we do need some inflation. It provides a stimulus to the economy – driving productivity, recruitment and wage growth. It also encourages us to spend, as we are more likely to buy something today if we think it will be more expensive tomorrow.

For this reason, the government sets the Bank of England (which controls monetary policy independently of political influence) an inflation target of 2% a year.

Although this rate is by no means high, it will still devalue the pound in your pocket over time. According to Retirement Advantage, with inflation at 2%, the value of your money will be halved in 35 years.

Mr McQueen says: “There is no cause for panic. However, it is still sensible to consider the impact it will have on your finances.”

You need to work out how much your household spending is likely to be affected by inflation. “Government figures are average and everybody’s spending habits are different, ” says Mr McQueen.

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Measuring inflation

The UK’s official measure of inflation is the Consumer Prices Index (CPI) – which monitors the changing prices of a basket of 700 consumer goods and services that are deemed to reflect the nation’s spending habits. This means the goods measured change each year – in 2015, sweet potatoes, e-cigarettes, online games subscriptions, headphones and craft beers went in; out went yoghurt drinks and sat navs.

But if its basket of goods doesn’t reflect your spending habits, then the official figure of inflation could be totally meaningless for you. Historically, for example, retired households have experienced a higher rate of inflation. “This is because their spending is so heavily influenced by the basic commodities – food, fuel, energy, transport and so on,” explains Fiona Tait, pensions specialist at Royal London, so when these costs rise, retiree inflation soars.

However, with increases to these particular costs slowing, this difference has become lessnoticeable in recent years.

Inflation hurts most if you are living on a fixed income that doesn’t go up in time. So just as you have enjoyed regular pay rises as an employee, it makes sense to ensure that your retirement income rises over time.

The good news is that a portion of your retirement income automatically rises every year and that is your state pension, thanks to the ‘triple-lock’ guarantee.

This ensures that your state pension will rise by whichever is the highest out of inflation, increases to average earnings or 2.5%. Former Prime Minister David Cameron pledged that the government will maintain the triple lock until 2020.

How safe it is beyond then remains to be seen. A cross-party government inquiry into inter-generational fairness was announced at the end of last year, while the Institute of Fiscal Studies has called for the triple lock to be scrapped on the grounds that pensioner incomes are being protected at the expense of other members of society. However, as Mr McQueen points out, with the over-65s more than three times likely to vote in general elections than the under-25s, it would take a brave party to scrap it. “There are politics and public finances to consider,” he says.

But with inflation-linked state pensions a certainty for the next four years at the least, those who are eligible may want to consider buying state pension top-ups to boost this income stream.

Currently, men born before 6 April 1951 and women born before 6 April 1953 are able to purchase additional state pension worth up to £25 a week. The option will be available until April 2017 and aims to appease those retirees who will not benefit from the new flat-rate state pension.

Cost depends on your age, but a 65-year- old buying the maximum £25 a week for life would need to pay £22,250. Whether or not it makes sense financially will depend on how long you live. “It’s worth serious consideration,” says Mr McQueen. “There are very few solid investment options that can guarantee you 2.5% a year.”

Buying an annuity

Another way to secure an inflation-linked income is to buy an escalating or inflation-linked annuity. These start off paying a lower income than level annuities but payments increase each year, either by a fixed amount or a direct inflation link. But while they are designed to help retirees cope with the rising cost of living, even annuity providers admit they may not be the best way of inflation-proofing your income. “They can be expensive and poor value,” says Andrew Tully, pensions technical director at Retirement Advantage.

This is because you may never recoup the income you lose in the early years. Take the example of a 65-year-old buying a £100,000 annuity today. Figures from Retirement Advantage show that with a conventional annuity they would receive a level income of £5,878 a year and after a typical 22-year retirement receive a total of £129,316. However, with an annuity that rises by 2.5% a year they would get a starting income of £4,031, which would have risen to £6,770 by year 22 but only paid out £116,346 in total.

While in both cases the retiree has had good value from their annuity, the figures suggest it is better to buy a level annuity and try to save any surplus. An alternative is an investment-linked annuity. As your money stays invested, in theory your income should rise over time.

Using the earlier example, an investment- linked annuity would start paying £5,270 a year, rising to £7,100 in the 22nd year. In total, it would pay out £132,950.

The downside is that if stock markets falter, your income could fall, though many plans have a minimum income guarantee to provide the reassurance it won’t drop below a certain level.

While annuities provide certainty and can be structured to provide some inflation protection, leaving money invested in one or a number of well-managed funds may be a more flexible route. Your capital should grow – which means it will be able to generate a rising income – but your money will also remain relatively easy to access should you need it.

Miss Tait says: “Equities are the only asset class to consistently outperform inflation over the long term.” With 2016 getting off to a volatile start stock market wise, this may not be an easy decision now, but savvy investors need to think ahead and consider how long their money might be invested. “Part of investing in equities is recognising there will be periods
of underperformance.”


Tony Stenning, head of retirement at BlackRock, agrees and says retirees should resist leaving surplus funds in the bank. “If you retreat into the nation’s obsession with cash, inflation will hit you hard. You’ll still have your pound in your pocket; it just won’t buy you very much.”

Unless you have a financial adviser, choosing the right funds can be difficult. So Mr Stenning is a fan of funds that have the freedom to invest across cash, bonds and equities. “A multi-asset strategy allows you to spread your eggs and lets the manager go where they need to get your income.” But while the experts agree investing is key to beating inflation, it is not without its risks.

For this reason, Mr Tully favours a “blended solution” using annuity and drawdown in combination. “Consider what your critical expenditure is – money for the house, fuel, shopping and so on. Get this income guaranteed, so the money for these costs will be there no matter what. The state pension will hopefully go some way in doing this, but you may need to buy some with an annuity. You can then leave your remaining money invested to provide a hedge against inflation.”

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