Rethinking your pension savings during the cost of living crisis

Mathilda Volant

by , Team PensionBee

at PensionBee

12 May 2022 /  

May 2022

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The Office for National Statistics reported that the price of consumer goods are increasing at the highest rate in almost 30 years. Similarly, the BBC reported that your food bill may increase by £271 this year because of inflation. In an ideal world (and economy) both our incomes and our outgoing expenses would rise in pace with each other. For example if the price of bread increased by 2% (along with our items in our shopping baskets) we wouldn’t necessarily notice it as much as our salary would have seen a similar growth that year.

However, when expenses overtake incomes we experience a cost of living crisis.

Along with the soaring inflation households in the UK are feeling the impact of rising interest rates, geopolitical tensions, supply chain disruption, labour shortages and the lasting effects of the coronavirus pandemic. All of these factors have contributed to where we are now.

What is the cost of living crisis? And why is this happening?

Simply put, the cost of living crisis is a direct result of income levels remaining the same while everyday costs have risen. This has meant that essentials have become less affordable to households here in the UK. The rising costs of shopping over the last year, is as a result of soaring inflation. Inflation is the rate at which the cost of things goes up each year.

The Government can measure inflation, using the Consumer Prices Index. They do this by comparing prices of basic goods and services each year (everything from bread to energy bills). From this, they can understand the change in household costs. The Bank of England sets a target of 2% for annual inflation. It’s important for inflation to be stable: both for businesses to set their prices and consumers to plan their spending.

March saw inflation hit the highest levels since 1992, and it continues to hover at around 7%. Between energy price hikes, geopolitical tensions throughout Europe, and recovering from a global pandemic - it’s unsurprising that inflation keeps rising. In response the Chancellor, Rishi Sunak, introduced policies to ease some of the pressure in the Spring Budget. Many people feel these measures haven’t gone far enough as the cost of living crisis continues to bite.

If you were alive in the early 90s, today’s economic outlook will be familiar. Inflation peaked at 9.5% in 1990 before gradually decreasing to 3.7% in 1992. During these years Prime Minister Margaret Thatcher resigned, a recession was announced, and people rioted over tax rates. 20 years later, we experienced another financial crisis. While the ‘2008 crash‘ had different causes, the outcomes remained similar. Then in 2020 the coronavirus pandemic triggered another recession for the UK economy.

Currently, we’re facing the risk of yet another recession if inflation doesn’t improve. However, there is good news. The Office for Budget Responsibility anticipates that inflation will decrease during 2023. While this doesn’t stop us feeling the pinch today, it also doesn’t stop us from planning for the future. There’s a precedent of recovery following market falls and pensions are long-term investments. If the global economy grows over time (which historically it has), then your pension should also recover over time.

So how does inflation affect pensions?

How does the current cost of living crisis impact your pension pot?

High levels of inflation impact pensions; both in the present and future.

The cost of living crisis has a ‘trickle up’ effect on our economy. When people have less money to spend, companies begin reporting losses as revenues plummet. For the first time in a decade Netflix lost subscribers, leading to almost a 20% fall in their share price. This isn’t surprising when every money guide out there advises cutting non-essential spending (such as subscriptions) then starting an emergency fund when we’re struggling financially.

Yet while we might make gains from reducing our outgoings as individuals, we may collectively feel the impact as savers with investments in the stock market, through Stocks & Shares ISAs and defined contribution pensions. If you had invested £100 in Netflix last year, the recent drop in share price would reduce your balance to £80. Fortunately, most investments are spread across many shares and different asset classes so we’re not usually reliant on a single company’s success for our money to grow. This is known as diversification.

Unfortunately, the cost of living crisis we’re currently facing has a long reach. And even diversified investments are experiencing slower growth, and losses in some cases. This combination of high inflation and a stagnant economy is known as ‘stagflation’. Navigating your finances safely through this turbulent period is tricky. However, there are a few simple steps that you can take now to boost your pension - without spending a penny.

1. Make workplace pension contributions

Although there’s legislation in place for employers to automatically enrol employees into workplace pensions, you can still opt-out. However, while regaining a small percentage of your gross salary each month may seem appealing it can be costly in the long run, as you’ll lose a 25% tax top up on your contributions from the government and a minimum employer contribution of 3% of your gross salary.

Yet the biggest benefit you’ll lose from opting out is compound interest. When your interest is added back to the original amount it begins a ‘snowballing effect’. Because it works by accumulating over time, compound interest can turn a small pension pot into a significant amount when left untouched for a long period of time. Opting out of your workplace pension can save you pounds now, only to cost you thousands in potential gains later - when you’re reliant on your retirement income to live.

2. Combine your pension pots

PensionBee CEO, Romi Savova, commented: simple steps such as combining any existing pension savings into one pot can have a noticeable effect on a savers’ eventual retirement income. Whilst this avoids savers losing out on any hard-earned savings, it also means that they only have to pay one set of fees, rather than multiple fees for various pots, which can erode a pension’s value over time.

If you’re already following step one, great! But opting in to all your workplace pensions could translate into many scattered pension pots as you switch jobs over the course of your working life. Defined contribution pensions (the most common type of workplace pension) are often managed and as a result have management fees. At first glance these fees may appear small but high charges can erode the value of your pension over time, if left unchecked.

You can find out where your old workplace pensions are using the Government’s free Pension Tracing Service, or by contacting your previous employer directly. Knowing the name of your pension provider and the policy number is key to consolidating your pensions.

3. Let your savings grow

It can be hard to know if you’re making the right decisions. And sometimes it’s tempting to take action for the sake of feeling in control again. An important thing to remember is that long-term investments don’t benefit from lots of short-term changes such as switching plans repeatedly. Financial products like pensions are designed for the long-term and thankfully aren’t reliant on investments consistently returning profits year on year.

Once you’ve committed to consolidating your pensions you should feel confident in your decision. While it can be difficult, try not to worry about short-term fluctuations as the value of your pension will ultimately be shaped by decades of stock market ups and downs. Instead, being conscious of your target retirement income and slowly building up a pension to support you in later life is a healthy habit you can start now.

Risk warning

As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.

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