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24th September 2017
:: Statistics | Inflation and its effect on pension benefits

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Inflation and its effect on pension benefits
 
Inflation and interest rates play an important role in pension provision, and there is a risk element involved with them both. For information on other types of risk see our Factsheet Security and Risk 
 
The effect of inflation on defined benefit pension schemes
In a defined benefit pension scheme low inflation and interest rates have increased the value of the pensions payable to members and tended to make schemes less well funded, which reduces member security. High inflation and interest rates will tend to have the opposite effect as it reduces the spending power of your pension during retirement.
 
Most private sector pension schemes have a ‘cap’ on the pension increases they pay to pensioners, so over the longer term, high inflation would erode the value of your pension. High interest rates reduce the value of members’ benefits but the security to the benefit itself should improve. However, in such situations in the past, politicians have intervened to make schemes provide better inflation protection on benefits.
 
The effect of inflation on money purchase pensions
For money purchase type pensions low inflation and low interest rates have reduced the amount of the pensions payable to members for a given amount of retirement pension fund. Unless the increased cost of buying a pension is offset by the size of the retirement fund being bigger, pensions paid will be lower. High inflation, which leads to high interest rates, will tend to have the opposite effect. High interest rates reduce the cost of members’ pensions.
 
To protect the value of pensions the key element in the cost is the real rates of return being paid on Government Index Linked investments. Currently these are still low, so the cost of an inflation-protected pension is high.
research.
Mike Jones, MyCompanyPension.co.uk Ltd, May 21st 2009
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