Does my private pension increase with inflation?

What is a private pension?

A private pension is one of the most important tools for securing a financially comfortable retirement.

Unlike the state pension, which offers a basic safety net, a private pension is a personal savings plan that you set up and contribute to throughout your working life.

It allows you to build a substantial retirement fund, giving you more financial independence and flexibility when you stop working.

There are two main types of private pensions UK residents can consider: 

Defined contribution

A defined contribution pension is the most common form of private pension in the UK.

You regularly contribute a portion of your earnings into your pension pot, and your employer may match those contributions.

The amount in your pension when you retire depends on how much you’ve paid in, the investment performance, and how long you’ve contributed.

While flexible, it doesn’t guarantee a set retirement income as it depends on market performance and your investment strategy.

Defined benefit

A defined benefit pension guarantees a fixed income in retirement based on your salary and years of service. It’s a more predictable form of pension compared to defined contribution, and some would argue it's the best private pension UK schemes could offer. 

However, these schemes are becoming rarer as they’re expensive for employers to maintain.

How do private pensions work?

With both pension types, you contribute money throughout your working life, which is then invested. Private pensions are designed to supplement your state pension, offering more financial flexibility in retirement.

One key difference between private pension UK schemes and state pensions is how they respond to inflation. 

In the UK, the state pension rises each year due to the triple lock, which ensures it increases by inflation, average earnings growth, or 2.5% — whichever is higher. 

Unfortunately, private pensions don’t offer this automatic protection.

Without planning, inflation can erode the value of your private pension over time, potentially reducing your purchasing power.

What is inflation?

Inflation is the gradual increase in the price of goods and services over time, meaning that the money you have today will buy less in the future.

The Bank of England aims to keep inflation around 2%. As of September 2024, inflation is 1.7%, down from a recent high of 11.1% in October 2022. 

Although this is below the 2% target and a positive sign of stability, inflation remains an important factor for retirement planning.

Even at a lower rate, inflation can still erode the value of fixed incomes, including private pensions, over time, making it essential to factor in when planning for your financial future.

How does inflation affect private pensions?

So, does my private pension increase with inflation? In most cases, the answer is no.

This is a crucial point to understand as you plan for retirement.

Unlike state pensions, which have triple-lock protection, private pensions are usually at the mercy of market forces unless you’ve made specific arrangements.

If your private pension is in a defined benefit scheme, some plans offer inflation-linked increases, but it’s not guaranteed.

For those with defined contribution pensions, your retirement income highly depends on your investment strategy and how much you’ve saved. 

Inflation can erode the real value of your savings, meaning even if you’ve done a great job building up your pension pot, the purchasing power of that pot could shrink over time. 

Essentially, without a strategy to combat inflation, you could withdraw less from your pension than you originally planned.

How can I protect my private pension from inflation?

Inflation is a reality we all have to contend with, but there are ways to protect your private pension from its effects.

Pension drawdown

Pension drawdown allows you to leave your pension pot invested while drawing income as needed. Your investments can continue to grow, helping to protect your savings from inflation. However, market fluctuations could also reduce the value of your pension.

State pension as a supplement

Using your state pension to supplement your private pension can provide a stable, inflation-proof income thanks to the triple lock. Combining both can help ensure your overall retirement income keeps pace with inflation.

Investment growth

Investing in assets that grow over time, like stocks or property, can also help protect your private pension from inflation.

If your investments beat inflation, your purchasing power in retirement can be maintained or even increased.

But remember, this strategy carries risk as your investments can fall in value, so it’s important to manage your portfolio wisely.

Annuities

You could consider purchasing an inflation-linked annuity, which provides a steady income that rises in line with inflation. While these annuities can be more expensive and may offer a lower starting income, they ensure your pension keeps up with inflation.

Should I be monitoring my private pension strategy?

Absolutely. Regularly reviewing your private pension strategy is essential to ensure it aligns with your financial goals and inflation expectations. 

Monitoring your investments, adjusting your withdrawal rate, and exploring inflation-protection options will help safeguard your retirement income.

Inflation can seriously impact your pension, so it’s crucial to stay proactive and ensure you have the best private pension you can access.

Get expert financial advice

While private pensions offer flexibility and the potential for investment growth, they are not automatically protected from inflation like the state pension. Understanding how inflation impacts your retirement savings is crucial to maintaining your purchasing power over time. 

By regularly reviewing your private pension strategy and considering options like drawdown, investment growth, and annuities, you can better safeguard your financial future. 

Let Unbiased match you with a professional financial adviser to ensure your private pension is protected from inflation and aligned with your retirement goals.