How will the cost of living crisis affect me?

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For customers

8 minutes read

With rocketing inflation and the growing cost of living crisis, people’s finances are under more and more pressure. Some will be finding it hard to cover the necessities, let alone having extra to spend on more enjoyable activities. Others will be finding it more difficult to put some savings behind them.

Here we answer 5 key questions about how the cost of living crisis could affect you. We also provide hints and tips to help you feel better equipped to manage your personal finances.

We’ve based this on inflation and interest rates as of 1 June 2022, at which point the latest inflation figure was 9% and the Bank of England base interest rate was 1%. These are likely to change over time.

1. Has the State Pension increased in line with inflation?   

For the last few years, the State Pension has been increased by what’s called the ‘triple lock’, the highest of price inflation (till September each year), national average earnings growth or 2.5%. However, this April, the triple lock was amended to omit earnings growth which had been distorted by the pandemic meaning that the State Pension rose by only 3.1%1 – whilst the rate of inflation for the year to April was 9%.2 This could leave those heavily reliant on the State Pension, and those who are already struggling with rising prices, severely stretched.

However, the Bank of England’s latest prediction that inflation might reach 10% or more later in the year, could result in a significant increase to the State Pension in April 2023, due to the Government confirming it will reinstate the triple lock which will use September 2022’s inflation figure. 2

The Chancellor recognised that pensioners are particularly affected by the current cost of living crisis and his support package includes some measures specifically targeted at lower income pensioners. This includes a special payment this year of £650 to households who are already claiming pension credit. If you haven’t checked if you’re eligible for pension credit, we recommend you do so even if too late for this special payment.

2. What benefits will the increase in the National Living Wage bring?

The National Living Wage (NLW) has increased from £8.91 to £9.50 an hour.3 Not only is this good news for individuals’ income, but it also brings with it increased pension contributions to workplace pensions, thanks to auto-enrolment. This applies for those who are eligible – including all employees aged 22 or over up to State Pension age and earning over £10,000 per year.

This will mean an additional £86 going into pensions over the course of the year. Last tax year, eligible employees working full-time on the NLW would have had a total pension contribution of £798, which will increase to £884 this year. This is based on an employee working at the NLW for 35 hours a week for 52 weeks, with a pension contribution of 8% being made on total yearly before tax earnings above £6,240.

While this may not seem a lot, a small increase could prove beneficial to future retirement savings – especially for those early in their careers. Remember, the value of an investment can fall as well as rise and isn’t guaranteed. The value of your pension pot when you come to take benefits may be less than has been paid in.

3. How will the rise in the rate of National Insurance impact my income?

National Insurance Contributions (NICs) will increase by 1.25 percentage points for employees, employers and the self-employed, to provide extra funds to the NHS and for the state’s share of Social Care reforms.4 While a worthwhile cause, it will reduce employees’ take-home pay and increase employers’ payroll costs.

However, the starting level of earnings on which you pay National Insurance (NI) will rise significantly to £12,570 as of July 2022. This will be welcomed by many – easing the impact of the 1.25% increase for those who earn above £12,570. And for those who earn £12,570 a year or below, they’ll not need to make any NI contributions – turning lower earners into net gainers.5

4. Will my take home pay be affected by the freeze on income tax thresholds?

The income tax personal allowance (the amount of income you don’t have to pay tax on) and the higher rate threshold (which is £50,270 other than in Scotland where it is lower) above which you pay higher rate income tax will remain frozen for four years from 2022/23 to 2025/26, rather than increasing in line with inflation as usual.6

What this means is that those who find that their salary is rising, perhaps in line with inflation, will see a larger proportion of their earnings subject to income tax due to this freeze. For example, an individual earning £30,000 last year and who receives a pay rise of say 5%, will pay an additional £300 in income tax in the coming year.

Additionally, many more people will find they become higher rate taxpayers even though their earnings may have failed to increase fully in line with the current high rates of inflation. Anyone earning over £48,000 last year, who receives an increase of 5%, will pay higher rate tax on part of their earnings in the coming year.

This information is based on our understanding of current taxation law and HMRC practice, which may change.

5. What’s happening to the pension lifetime allowance?

The pensions lifetime allowance (the total amount of money you can build up over your lifetime in your pension pot without incurring a tax charge) will remain at £1,073,100 until April 2026, having been frozen last year.7 Individuals whose pension pot grows to more than this amount will need to pay an extra charge unless they have special ‘protections’ in place.  

In the current climate of soaring inflation, continuing to freeze the amount that can be built up in a pension without incurring a tax charge may have an adverse impact on an increasing number of people if their pension pot grows above £1,073,100.7

The lifetime allowance may sound like a huge sum but it’s important to work out how long you will be retired for and how much income you will need each year to support the retirement lifestyle you would like to live. To help break this down further, consider if your monthly retirement income will be enough for you to pay your living expenses – whilst enjoying what you’d like to do in your retirement from hobbies to holidays or spending days out with your loved ones.

6 hints and tips to help you with your finances

  1. Budgeting methods – if you’re currently relying on the State Pension or a fixed income, you might want to consider reviewing your budgeting method to help your income go further. Following the traditional budgeting method, you might create a list of incomings and outgoings and identify where to spend or save. Or the 50-30-20 budget asks you to dedicate a percentage of your income to different categories. The split is typically 50% towards needs, 30% towards wants and 20% towards goals but you can amend this to suit your own situation.
  2. Pension basics – learn what you need to know about pensions. Knowing the different types of pension plans you have, how they work and how you can take your pension benefits, should help set you up in good stead when you’re saving and planning for your retirement.
  3. The State Pension – often the State Pension is an individuals’ main source of income when they retire but it’s always good to have other sources of income to help you live a comfortable life in retirement. Your retirement pot could consist of workplace pensions, personal pensions, ISAs, investments and the State Pension. Explore the different options available to you and consider accumulating money in your workplace pension, as your employer will also be contributing to this as part of auto-enrolment. You can also read our guide to understand more about the State Pension and what this means for you. 
  4. Budget review – if you’re finding the cost of living squeeze challenging, a budget review might help you identify where you could save a little more to help tide you over. Remember to keep your goals achievable by dividing them into short, medium and long term – and regularly review your progress against each to help you make any necessary adjustments.
  5. Pension contributions – most people are not saving enough to provide them with the lifestyle in retirement they aspire to. Consider the following:
  • Think about the retirement lifestyle you’d like and how much income you would need to support this lifestyle.
  • Review your existing pension plan(s) to see if you’re on track to reach your retirement goals.
  • Think about where your pension is invested – does it suit your needs and reflect your values?
  • Read on to find out more about How you could contribute more towards your pension and How to prepare for retirement.
  1. Pension credit – if you’re above State Pension age, check if you’re eligible for pension credit. Too many people fail to claim this, but it can make a big difference particularly during a cost of living squeeze. Under the Chancellor’s cost of living support package, existing pensioner credit claimants qualify for an additional £650 special payment.

Inflation is affecting us all differently

Clearly, the cost of living crisis and high levels of inflation affect everyone differently – it’s about finding the best way to adapt your finances to help you get through.

If you’re unsure about how any of these changes may affect you, we recommend you speak to a financial adviser. You can also get guidance, or help finding a financial adviser, through MoneyHelper.

You can find more articles on our Customer Perspectives hub about money management, hints and tips to help you save money or learn more about pensions and how to prepare for retirement.

 

Sources:

1State Pension and benefit rates for 2022 to 2023 confirmed. Data source, GOV.UK, November 2021.

2Bank Rate increased to 1% - May 2022. Data source, Bank of England, May 2022.

3National Minimum Wage and National Living Wage rates. Data source, GOV.UK, May 2022.

4 Rates and allowances: National Insurance contributions. Data source, GOV.UK, June 2022.

5National Insurance Contributions (Increase of Thresholds) Bill. Data source, House of Commons library, UK Parliament April 2022.

6Spring Budget 2021: personal allowance & higher rate threshold. Data source, House of Commons library, UK Parliament January 2022.

7 Setting the standard Lifetime Allowance from 2021 to 2022 to 2025 to 2026. Data source, GOV.UK, March 2021.