Daniel Hough: Surge in the cost of living presents big challenges for retirement planning

Few people will have missed news of price rises: inflation hit a 10-year high as the consumer  price index (CPI) rose to 5.4 per cent last month. There may be more to come, however, with expectations that it could surge to 6% by the spring – a level not seen for decades. 

Many people will be worrying about how they can mitigate against the rise in the cost of living, while those with money stowed away may be fretting about the corrosive effect inflation can have on their savings.  Before making any decisions, assess your financial situation by carefully updating your budget to factor in the rising costs of everyday items such as fuel, energy, and food.

Remember to also consider the higher rates of National Insurance and frozen income tax bands from April this tax year – particularly if you have been fortunate enough to have recently received a pay rise. 

Doing this will give you a good idea of where you are and how inflation is going to affect your financial situation in real terms. It will also give you a feel for what you need to keep in cash as an emergency fund. If you are able to, we generally suggest keeping at least six months of essential expenditure readily available. 

Another important step for those who can afford to save, is to make the most of the tax allowances available to you. One of the most important – particularly from a savings perspective – is the Individual Savings Account (ISA) allowance, which can give you the opportunity to shield cash, investments and their income from tax.

While cash ISAs are more popular among savers, interest rates are typically still very low. So, if you want your savings to have a fighting chance of keeping pace with inflation, we suggest setting up a stocks and shares ISA, bearing in mind this can come with volatility and requires an investment horizon of at least five years.  This allows you enough time to ride out any fluctuations in the market that might see you make a loss in the short term.

You may also want to consider maximising the efficiency of any pay rise or bonus you might have been lucky enough to receive, by increasing pension contributions or employment schemes and benefits. Many employers offer options such as share incentive plans, cycle to work schemes, private healthcare and other initiatives that  are deducted from your salary before tax.

While your take-home pay may be lower,  with a pension you are saving for the long term and will benefit from the tax relief on your contribution.   Another point to consider during inflationary periods is your insurances and contracts. Staying loyal to your current provider may see you paying more than you have to, and it’s usually worth exploring comparison websites to make sure you are getting the best deal. A fixed rate contract is usually preferable, providing certainty over costs.

In retirement, inflation is one of the most significant financial challenges if you have a fixed budget or income. However, whether you are approaching retirement soon or it is still some way off, we would advise reviewing your retirement plan. Mapping out retirement goals and a target income gives you an idea of what you need to do to boost your retirement savings now, for when the time comes.

Of course, bear in mind the Lifetime Allowance – the amount you can save into your pensions without facing additional tax charges on withdrawal. This will remain frozen until the 2025/26 tax year at £1,073,100. While that might seem a lot, rising asset prices will mean more and more people are at risk of breaching it.   Planning your finances can be a complex landscape to navigate in times like these, and we would recommend speaking to a financial adviser more so than ever. While heightened inflation is reported to be temporary, it is, generally speaking, good to hope for the best,  but prepare your finances for the worst.

Daniel Hough is a financial planner at Brewin Dolphin.

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