How Inflation Can Impact Your Pension?

The Silent Thief: What Exactly Is Inflation?

Before we begin to discuss pensions, let"s quickly understand the problem. Inflation is the rate at which the general level of prices for goods and services in an economy increases over time. As prices increase, the purchasing power of money falls.

The reduction in the purchasing power of money is called a loss of purchasing power. It just means a rupee today can buy you less than a rupee could buy you yesterday.

As you begin planning your retirement, it"s easy to think of a huge corpus, say ₹1 Crore, in the future and think of yourself as being incredibly secure. However, because of the effect of inflation, the purchasing power of ₹1 Crore in the future, say 20 years down the line, will not be the same as the purchasing power of ₹1 Crore today. In fact, if inflation averages around 6% per annum, the purchasing power of money can reduce significantly over time, roughly halving in about 12 years.

The Real Impact of Inflation on Pension Savings

So, how does this directly affect the money you are putting away for your retirement? The real impact of inflation on your pension income depends on the type of pension fund you have. Let's consider a few examples.

1. The Problem with Fixed Pensions (Like EPS)

   If you are part of the organised workforce in India, then a part of your employer's provident fund contribution under the Employees' Provident Fund Organisation is allocated to the Employees" Pension Scheme (EPS), which provides a defined monthly pension after retirement.

   A fixed income every month sounds like the safest option in the world, but there is a catch. A fixed income does not increase in line with the inflationary increase in the prices of goods and services. If your fixed income is ₹5,000 every month when you retire at the ripe old age of 60, then it will still be ₹5,000 when you are 75 years old. But when you are 75 years old, your living expenses, medical bills, and the price of your daily groceries will be through the roof. A fixed income means the real impact of inflation on your pension savings is severe.

2. How It Affects Your Provident Funds (EPF and PPF)

   We all depend quite heavily on our Employees' Provident Fund and Public Provident Fund savings as part of our retirement planning strategies. These are wonderful instruments that can be used to our advantage, providing assured returns that are backed by the government.

   But we must analyse the situation from the financial point of view as well. If the rate of inflation is rising at 6% to 7%, and your EPF and PPF investments are providing you with an average return of 7% to 8%, you are preserving your wealth. However, you"re not growing it quite fast enough to beat the rising costs of living and the effects of the inflation rate.

How to Protect Your Golden Years

Now that we've told you the drawbacks, let"s tell you the good news too! You can manage this problem with a disciplined and well-diversified investment strategy. To beat the effects of the rising cost of living, your money must grow faster than the rate at which the cost of living is rising.

Here are the best ways to do it!

1. The Importance of NPS

   While discussing NPS and EPF, it is imperative that we discuss why the National Pension System (NPS) has emerged as a highly sought-after option for modern-day retirement planning.

   The National Pension System is different from fixed-return investment options in that it provides you with a platform to invest a certain amount in the stock market (equity). Although the stock market experiences short-term ups and downs, over the long term (15-20 years), it is one of the few investment options that has the potential to outperform inflation over the long term, although returns are market-linked and not guaranteed.

   By investing in the National Pension System, you can grow your money much faster so that when you retire, you can enjoy a much higher buffer against inflation on the money you receive from your annuity purchases.

2. NPS at a Glance via Pensionbazaar

   Feature	Details
   Minimum Contribution	₹500 per contribution
   Investment Options	Equity, Corporate Bonds, Government Securities
   Expected Returns	Market-linked, historically 8% to 12% (not guaranteed)
   Tax Benefits	Up to ₹2 lakh under Sections 80C and 80CCD(1B)
   Lock-in Period	Till retirement, partial withdrawals are allowed under certain conditions
   Flexibility	Choose asset allocation and fund manager
   Annuity Requirement	A minimum of 40% of the corpus to be used for annuity at retirement

3. Diversify Your Retirement Planning

   Don"t put all your eggs in one basket! Relying solely on your fixed pensions or the stock market is not the way to go.

   • The Safety Net

     Keep your foundation solid with assured schemes. Combining NPS and EPF is simply fantastic! Your EPF acts as a relatively stable component of your portfolio, with returns declared annually and not directly exposed to market volatility.

   • The Growth Engine

     Mutual funds and the equity component of your NPS will be your engine that will propel your wealth into the stratosphere! This is the portion that will rise above the ravages of inflation.

   • Healthcare Costs

     Medical inflation is much higher than other inflation. Ensure you have a good health insurance plan in place so that your hospitalisation doesn"t wipe out your hard-earned pensions.

Conclusion

The impact of inflation on your pension savings is not just something that is abstract or theoretical. It is something that will actually impact your quality of life when you are older. Safe, fixed-return investments are wonderful to have in your portfolio, but these are also generally not effective at beating inflation in the long term. By taking charge of your own retirement planning and diversifying between fixed-return investments and growth-orientated investments, you are actually able to beat inflation successfully.