CPI falls to 2.3% but has it fallen far enough for DC savers to catch up?

On 22 May, the ONS announced that the UK Consumer Prices Index rose by 2.3% in the year to April 2024, the lowest rate since July 2021. The Bank of England has stated that “Inflation could fall to our 2% target in the next few months…” But what does this really mean for people saving for retirement in a DC pension?

Inflation is in the eye of the beholder

Let’s start with what lower inflation doesn’t mean, it doesn’t mean prices are falling. A lower rate of inflation, or disinflation, just means that prices are getting higher, but less quickly than before. What the headlines don’t reveal is that the cost of a decent retirement is still racing away from an average DC saver.

Inflation measures the change in price of a basket of goods and services which is regularly updated to reflect shopping trends and changes in consumer behaviour. For example, in March 2024, the Office for National Statistics updated the basket of goods underlying the Consumer Prices and Retail Prices Indices to include items such as air fryers and gluten-free bread, whilst they removed hand hygiene gel and hot rotisserie-cooked chicken.  But different people need and buy different things, and so everyone experiences their own unique rate of inflation. With price changes varying materially for different goods, this individual inflation effect is exacerbated.

What is the rate of inflation for those in retirement?

Helpfully, in 2019 the Pensions and Lifetimes Savings Association (PLSA) published their Retirement Living Standards which give an intuitive and easy to understand target for DC savers. They design the basket of goods based on what retirement could look like in terms of how much is spent on things like DIY, food, holidays, clothing, etc. for a ‘minimum’, ‘moderate’ and ‘comfortable’ level of income in retirement. 

This measure of inflation is therefore really useful when thinking about retirement planning and setting your sights on what is likely to be an adequate amount to save and supersedes the traditional “replacement ratio” which simply estimates what proportion of salary is needed to support a good post-retirement lifestyle.

How has the cost of retirement changed over time?

The amount a single person outside of London would need for the ‘minimum’ standard increased 12.5% from £12,800 in 2023 to £14,400 in 2024; ‘moderate’ is up 34% from £23,300 to £31,300 and ‘comfortable’ is up 15% from £37,300 to £43,100. For single people living in London, each Standard is between £1,300 and £1,900 higher and couples need around 1.3x to 1.5x more than single people. 

These large increases have been led by changes in the types of goods and services underpinning the standards but there have also been substantial increases in the costs of some items. The backing report from the Centre for Research in Social Policy (who produce the research used by the PLSA) shows that increases in the food category account for a third of the overall increase in the moderate standard. Half of that increase being the inclusion of a new item of £100 each month to take family or friends out to eat.  

This shows how sensitive the standards are to changes in both people’s needs and wants in retirement. In fact, the moderate standard has increased by 55% since release in 2019 whilst the Consumer Prices Index has only increased by around 21% over the same period.

What does this mean for retirement planning?

Likening saving for retirement to the 1977 film “Smokey and the Bandit”, this growth in retirement living standard inflation is like the Bandit accelerating away from Sheriff Buford T. Justice. The Sheriff now needs to speed up to catch his target, the Bandit. In DC world, this essentially means achieving higher investment returns or paying higher contributions (through a higher contribution rate or a higher salary) to help close in on the retirement living standards.

The current full UK state pension increased by 8.5% in April 2024 to £11,502 p.a. which helps towards the increases needed to keep up with the Retirement Living Standards. True to the film, the Bandit has taken the lead, but of course, unlike the film, we’d rather the Bandit didn’t get away!

The pot at retirement needed over and above the state pension to target the updated moderate outcome is now of the order of 65-70% higher than last year. Someone on a median salary starts saving in their early 20s and targeting the moderate living standard would need an extra 6% to 8% p.a. in contributions, or 2% to 4% p.a. additional investment returns over the whole of their savings journey. With real rates higher now than a few years ago, the extra return may be achievable for new joiners. However, anyone mid-career will need more than this to boost their pot at retirement sufficiently over the shorter time period - much like the theme tune, they’ve got a long way to go and a short time to get there! 

What should be done to keep up with the inflation bandit?

It’s well known that contributions need to be higher than auto-enrolment minimums to deliver adequate retirement outcomes for most of the UK population, but this is an extremely difficult message during a cost-of-living crisis. That's why it's crucial for those managing investments to ensure their investment strategies are effective, aiming for solid returns while aligning with realistic goals.  

Maybe the current focus on private markets, with their potential for higher, inflation busting returns is well timed? Their illiquidity has been long considered a barrier for DC schemes, but it’s time to see if as an industry, “We gonna do what they say can’t be done.”