1. Demand-pull effect – this is when an increase in spending power increases the demand for goods and/or services. This increase in demand then leads to a rise in price.

2. Cost-push effect – when production costs increase, there’s a need to increase the total price of the goods being sold.

3. Built-in inflation – this type of inflation occurs when the natural rise of costs is reflected by a rise in salary or wages. An increase in wages means someone can purchase more with their money, and the cycle continues.

When using our Inflation Calculator, you’ll notice that we’ve included an assumed annual rate of inflation of 2.5% in your pension projection. 2.5% is the assumed annual rate of inflation used by the Financial Conduct Authority (FCA).

Though inflation rates will fluctuate year to year, over time they will generally stabilise. A period of inflation may be followed by a period of deflation, when prices decrease and purchasing power increases, such as in 2009 when the UK experienced its first fall in prices in nearly 50 years. A projected annual inflation rate of 2.5% means that the purchasing power of your pension pot reduces by 2.5% each year until you retire. By factoring in this rate of inflation, the projected value of your pension at retirement is shown in real terms and in accordance with the number of years you’ve got left to save. In other words, how much your projected pension amount would be worth today.

Pensions aren’t immune from the effects of inflation, both when you’re saving into your pension and when it comes to drawing down in retirement. The money paid into your pension is invested in different asset classes and their value can decrease as well as increase over time. However, for each year that your pension is eroded by inflation, its potential for growth is impacted. For example, if your pension pot value grew by 5%, but inflation was at 2.5%, ultimately your pension would have grown by just 2.5%.

When it comes to retirement, you’ll want to be supported by your pension for as long as possible. The impact of inflation on your pension will depend upon how much you’ve saved, and how you plan to access your money.

As a long-term investment, intermittent ups and downs don’t usually have a lasting impact on pensions as most savers will have plenty of time to ride out these bumps, and benefit from the long-term growth opportunities. But for those closer to retirement, a pension has less time to recover from these losses. This is why it’s important that savers take a balanced approach when looking at how best to protect lifetime savings.

For many people, an annual retirement income that’s two-thirds of their current salary is a reasonable amount to retire on. This means that if your annual salary is currently £35,000, then just over £23,000 per year would give you a sensible retirement income. You can also refer to the Retirement Living Standards from the PLSA for guidance.

If you’re likely to be eligible for the Full State Pension, you’d currently receive £11,973 per year (2025/26). This should be factored into the total value of your pension pot. Currently, all savers can claim their State Pension from the age of 66. However, this is set to increase to 67 by 2028.

To find out more about how much value existing workplace and personal pensions could generate in retirement, you can explore our Pension Calculator, which also allows you to take the State Pension into account.