Originally published at: https://blog.investengine.com/do-pensions-rise-with-inflation/
Over the last few years, inflation has been one of the key economic factors influencing both individual decisions and broader government policy.
What exactly is inflation, though? And how could it affect your pension over the years and decades before you retire?
Let’s break it down so you are aware of exactly how pensions can be impacted, and what investors can do to try to protect their money for the future.
What is inflation?
At its simplest, inflation is the process of things getting more expensive over time. As the price of food, clothes, fuel, and other necessities goes up over time, money becomes less valuable. For example, £10 today doesn’t buy as much as it did in the 1990s.
The UK’s Office for National Statistics measures inflation by tracking the cost of around 700 everyday items. They combine these prices into something called the Consumer Price Index (CPI). When the average price of this basket goes up, that’s inflation.
Source: Bloomberg
Over the last decade, inflation in the UK has generally been between 2.5% and 5% per year – the Bank of England’s target tends to be 2%. In the early 2020s, UK inflation spiked to over 10% as a result of broad geopolitical and economic shocks.
How does rising inflation affect your pension?
If prices keep going up, it means the value of the money you save can shrink unless it grows too.
Pension schemes tend to invest client money in a mixture of stocks, bonds, and other assets, with the express aim of growing that pot faster than inflation. This helps retirement funds to maintain their value or even increase it over time.
Let’s use an example to demonstrate how much difference inflation can make over time. Imagine two investors, both putting away £250 a month for 20 years.
- Investor A puts their money in a savings account with 0.5% interest rate.
- Investor B puts money into a pension and invests it, achieving a growth rate of 7% yearly.
In 20 years, Investor A will have approximately £63,089 in their pot, and with a realistic average inflation rate of 2.8%, then it amounts to just £36,315.
Same goes for Investor B. After 20 years, they will have £130,232 in their pension pot. Adjusted for inflation, this will be worth around £74,964.
Remember that investments can go up and down in value, so you could get back less than you put in. These figures are simulated without taking fees into account.
Does the State Pension rise with inflation?
The short answer here is yes, the UK State Pension does rise with inflation.
The UK government uses something called the “triple lock” to protect state pensions from inflation. Each year, the State Pension increases by the highest of:
- Inflation in the September of the previous year, using a measure called the Consumer Prices Index (CPI)
- The average increase in total wages across the UK for May to June of the previous year
- Or 2.5%
This helps make sure your State Pension payments keep pace with the rising cost of living. But it only applies to the State Pension, not private or workplace pensions.
Do private pensions rise with inflation?
Private pensions or SIPPs don’t have the triple lock guarantee. When you retire and withdraw a fixed amount every year, inflation can reduce the value of those payments over time.
That’s why many experts recommend keeping part of your pension invested even after you retire. This way, your money can keep growing and hopefully stay ahead of inflation.
What could you invest your pension in?
So, to try to ensure that private pensions don’t get eroded over time by inflation, many people turn to investing.
When deciding where to invest your money, managing risk is an important consideration. So, you’ll want to find the options that best suit your risk tolerance and your time horizon.
With a pension, it’s all about balance. From lower-risk options like money market funds to potentially higher-growth options like equity ETFs, there are a number of options out there to suit individual goals and time horizons.
Let’s take a look at a couple of options:
Money Market Funds
Money market funds are designed to offer a lower-risk investment option, which aim to minimise the risk inherent in investing and deliver modest returns.
These funds track the Bank of England’s SONIA rate, which is itself a benchmark which aims to represent the average interest rate across the major banks. At the time of writing (June 2025), the SONIA rate is sitting at 4.21%.
You can hold money market funds within a SIPP. They might be particularly useful for those approaching retirement, as they tend to offer lower volatility when compared to other asset types.
Index-tracking ETFs
The other side of the coin is investing in ETFs that track indexes. These funds track a particular index, such as the FTSE 100 or the S&P 500.
Because they track financial markets like the S&P 500, they can potentially offer higher growth than money market funds or other lower-risk investments, but come with the risk inherent in markets. For investors, investing in index tracking ETFs offers opportunities to diversify an investment portfolio.
Equities can fluctuate in value, and short-term losses are possible — particularly during periods of market volatility. These types of investments may suit those with a longer time horizon and higher tolerance for risk.
As ever, if you’re unsure what’s right for you, consider speaking to a qualified financial adviser.
Important information
Capital at risk. The value of your portfolio with InvestEngine can go down as well as up and you may get back less than you invest. ETF costs also apply.
This communication is provided for general information only and should not be construed as advice. If in doubt you may wish to consult a professional adviser for guidance.
Tax treatment depends on personal circumstances and is subject to change, and past performance is not a reliable indicator of future returns.