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The rise in inflation impact on pension schemes and public policies in LMIC countries

As inflation surges and impacts our everyday living, it is impossible to ignore how it could erode the value of our investments. A Reuters survey showed that global public pension schemes and sovereign wealth funds managing more than $3 trillion in assets fear a combination of economic slowdown and higher inflation in the next 12-24 months. Pensioner households are said to need a basic £20,000 a year in income for a comfortable retirement, analysis from ISIPP has found, although the provider warned that inflation is placing growing pressure on pensioner finances. In most developing countries public service pensions are increased every year at the same rate as the additional state pension. The statutory requirement is for the additional state pension to increase by at least as much as inflation, however that doesn’t hold the same in low- and middle-income countries.

With inflation widely expected to hit 10% this year, below-inflation pension increases look set to become the norm. This will mean that pensioners with DB pensions will be worse off in real terms. On a general scale, the public and private sector defined benefit pensions are affected differently. Defined benefit pensions provide a guaranteed income for life similar to annuities, except this time the promise is underwritten by the employer. In the case of public sector pensions, that employer is the state, meaning pensions are essentially underwritten by taxpayers while the impact of inflation on private sector defined benefit pensions will depend on the rules underpinning the scheme. Often these rules will place a cap on inflation protection, meaning they won’t enjoy the same increases as their peers who worked in the public sector.

In particular, a prolonged period of high inflation may also see a new set of challenges for members making use of pension freedoms to flexibly access their DC pension savings. With many people now self-managing drawdowns, retirees face a difficult choice between drawing down more now in order to maintain their current standard of living and trying to preserve their savings for use in later years. The danger of withdrawing savings earlier than you might otherwise have done is that those savings stop working for you and you miss out on the potential for future growth. The vast majority of DB schemes that have closed to further accrual is another significant development in the pensions landscape. The security against inflation provided by having their pension benefits tied to their eventual final wages will no longer be available to participants in these systems. Employers and trustees of DB schemes that are thinking about closing to further accrual in the current climate will also need to take this problem into consideration.

The Financial Conduct Authority said today that all non-workplace pension providers will need to issue a “cash warning” to consumers with a certain level of cash in their pension, outlining how high inflation will erode their savings. The FCA said the cash warnings are intended to protect consumers who have already held “a significant and sustained” level of cash in their pension and are intended to prompt consumers to consider whether they should remain in cash or switch to “growth assets”. Despite not receiving much attention in developing nations, when the impacts of inflation become more noticeable, trustees and employers of pension schemes may face pressure from members to grant discretionary increases over what is allowed by the scheme rules.


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