Deflation has not been seen in the UK since 1960 so why are we threatened by this today and what does it mean for our pensions? It’s a very common question at the moment with very little answers which makes the importance of this article extremely demanding. Low inflation and deflation concerns could be blamed on a number of factors such as low oil prices or supermarket price wars. Usually deflation is associated due to a reduction in money or credit. How can this be when mostly every central bank in the world are increasing money supply through quantitative easing (QE)? The question as to why we are in this mess is debatable but the question as to how it will affect us is what we need to know.
Thankfully for any of you who will or have qualified for a state pension will never see their state pension fall due to negative inflation as it is currently protected by the ‘triple lock’. This means the state pension will increase each year by the higher of inflation, average earnings or 2.5%. The ‘triple lock’ policy is fairly new which is now under review with Theresa May stepping in as the new Prime Minister for George Osborne, although the government have assured the public that it will remain until 2020.
Defined Benefit Schemes
Defined Benefit Schemes are designed to pay you a salary on retirement until death based on your final salary and years in service which increases by CPI (inflation) each year. The first question that springs to mind is “If we have deflation, does that mean my pension will fall in value each year?”. The short answer is no. Most Defined Benefit Schemes have a 0% floor, although this can differ depending on scheme rules. This means that if inflation stays low for a long time like seen in Japan, the increase in your pension will be very limited or even non-existent. The opportunity cost of a defined contribution scheme may become more attractive for a lot of people who believe low inflation (low returns for scheme members) is here to stay.
Of course this could be a blip but with the ever concerning deficit in defined benefit schemes, many people are transferring their scheme’s to a personal pension scheme. It is important to seek independent financial advice before considering a transfer as many factors need to be taken into consideration to ensure it is in your best interest.