Inflation is real and it is here. There are lots of factors behind this, the rising price of petrol, surging gas prices, supply issues and the pandemic pushing up the cost of even the most basic food items.
With inflation surging, now is the time to review your savings and investments to establish if they are suitably structured to provide protection from this threat. Inflation is the moth that eats away at your savings and income. The inflation rate reduces the value of the income of fixed income earners such as wages and pensions. This calls for continuously increasing the income to ensure that employees’ standard of living is not rapidly depleted. The present value of the pension contribution from the total wages for the entire working life and the expected pension is determined at the assumed interest rate. The present value of the pension fund contributed is evaluated at the rate of inflation to know if it can guarantee a reasonable standard of living at retirement. Pensions generally increase each year in line with inflation and an increase in inflation means that a higher value is placed on defined benefit liabilities.
The long-term consequence of this could be that employers have to pay more into their schemes or, as we’re seeing happen more frequently, many may no longer feel that they can continue to support the schemes and will close them and offer an inferior defined contribution arrangement in its place. Given that pensions are such a crucial preparation for retirement, it is worth looking at how they can be affected by changes in the rate of inflation. It is worth noting that if you have a final salary pension, it is supposed to increase in value in line with inflation, and this means a higher value is placed on defined benefit liabilities. Ultimately, continued rises in inflation along with low-interest rates could spell bad news for pensions.
With rises in inflation potentially threatening the stability and existence of current pension schemes as we know them, effective solutions are needed to ensure that people can afford to sustain themselves in retirement. One solution could be to pool resources together into super-funds, which would allow greater investment opportunities and potentially mitigate the risk of current pension schemes collapsing.
If one thing is for certain though, it is that pension schemes will have to change in order to keep up with the changing economic climate. It is clear that the future of pensions could rest on inflation figures for the coming years. As for the long-term future, much will depend on how the economy performs.
Namibia faces a number of challenges in reforming and providing for a comprehensive, affordable and sustainable pension system. Existing pension arrangements are not well suited to meet the challenges of an ageing population. Inflation has exacerbated the problems pension schemes have been facing and pensions still face a rocky road ahead, despite positive predictions for the coming years. Those with defined benefits pension schemes would do well to keep an eye on any developments to navigate potential future risks. Schemes that have seen their liabilities come down will be breathing a sigh of relief but the benefit will be erased pretty rapidly if inflation expectations increase significantly. Now, more than ever, is time to consider alternative methods of drawing a retirement income, such as flexi access drawdown that allows retirees to access cash when the need arises, with the added benefit of the upside potential market exposure. Inflation doesn’t just impact what you can afford today, but also what you could afford in the future.
The cost-of-living adjustment is critical to retirees over time. As inflation raises costs, fixed pensions lose the sufficiency to sustain people in later years. Pensions are a great way of saving for the future. Not only is your money invested with the aim of growing over time, but your employer and the government will also pay into it for you. If you leave your pension invested and make regular drawdowns, inflation will continue to erode your pension. However, this could be offset if the growth of your investments outpaces inflation. As we’ve seen, inflation has the power to erode the value of your money over time. This is particularly true if you leave your money under the mattress, or even pay it into a low-interest savings account. One way of protecting yourself against inflation is to invest your money in a pension, which tends to grow at a faster rate than inflation over time. We should know that inflation is our enemy and work to control it. No one can hide from inflation. However, some employer pensions are not protected against inflation.
Lastly, the various pension reforms should be reviewed periodically, and implementation of more such reforms year after year should be done as it tends to positively impact total pension benefits paid out in the long run. It is obvious that inflation matters in different ways to different parts of the economic value chain and depending on which type of inflation we are seeing, different companies will benefit or suffer in different ways.