What happens to your plan if inflation averages 4% rather than 2%?
The Bank of England targets 2%, and a plan built on that assumption is exposed to the difference if the outcome is 4%. Over thirty years the gap is not marginal: prices roughly double at 2% and roughly triple at 4%, so the same level income buys around a third less in the second case than in the first.
- The compounding: prices roughly double over 30 years at 2% and roughly triple at 4%.
- What is protected: the State Pension under the triple lock, and index-linked annuities and gilts.
- What is not: a level annuity, cash, and conventional bonds held to maturity.
- The frozen part: tax thresholds, which are held in cash terms and pull more income into tax.
01 The arithmetic of two extra points
At 2% inflation, £30,000 of spending today costs about £54,000 in thirty years. At 4% it costs about £97,000. That difference is not a market outcome or a forecasting error; it is compounding applied to a rate that differs by two points.
For someone holding a level income the effect is a steady erosion that never announces itself. A level annuity of £15,000 bought at 65 buys the equivalent of about £8,300 at 2% inflation by age 95, and about £4,600 at 4% — from an income that has never changed in cash terms.
The Bank's target is 2% and its own reports set out how far actual inflation has run from it in recent years. Treating the target as a forecast is the assumption that produces the problem.
Shows: what your spending costs in future money at two inflation rates, and what a level income is worth by then. Ignores: tax, investment returns, and any inflation protection on your income.
On the defaults above, the worked example shows £97,302. At 2% the same basket costs £54,341; at 4% it costs £97,302 — a difference of £42,961 a year.
Source: Bank of England on inflation
02 What holds its value and what does not
The State Pension is protected by the triple lock, rising by the highest of earnings, CPI or 2.5%. Index-linked annuities and index-linked gilts track inflation directly, at the cost of a much lower starting income or yield. Defined benefit pensions usually escalate, though often with a cap that binds in a high-inflation year.
Level annuities, cash and conventional bonds have no protection at all. Neither, in real terms, does an income drawn from a portfolio unless the portfolio grows fast enough to fund the increase — which is the argument for holding growth assets across a long retirement rather than against it.
The caps matter more than they look. A defined benefit pension escalating at CPI capped at 5%, or a deferred pension revalued at a capped 2.5%, falls behind permanently in years where inflation exceeds the cap, and those shortfalls are never made up.
Source: Consumer price inflation, UK
03 The tax side of high inflation
Frozen tax thresholds turn inflation into a tax rise. The personal allowance and the higher-rate threshold are held in cash terms until April 2028, so an income rising with prices moves into higher bands without any real increase in living standards.
For a retiree that bites twice: the State Pension rises under the triple lock toward a static personal allowance, and any drawdown income rises alongside it. The interaction between the two is what turns a 4% inflation scenario into a materially higher effective tax rate.
Planning in real terms rather than cash terms is the defence. A plan built on nominal numbers with frozen thresholds understates the tax bill in every year until the freeze ends.
Inflation is the risk that does not look like a risk, because nothing happens on any particular day. A level annuity at 65 halves in real terms by the late eighties at 2%, and does far worse at 4%, and at no point does anyone send you a letter about it. This is why I keep pushing people toward index-linked income for the essentials even though the starting figure looks worse. A smaller income that rises is a different asset from a larger one that does not, and over thirty-five years it is not close.
FAQ
Is 2% a reasonable planning assumption?
It is the Bank of England's target rather than a forecast, and actual inflation has run well above it in recent years. Planning on the target and testing the plan at a higher rate is more robust than assuming the target will be met.
What protects a retirement income from inflation?
The State Pension under the triple lock, index-linked annuities and index-linked gilts, and defined benefit pensions that escalate — subject to any cap. Level annuities, cash and conventional bonds have no protection at all.
Do frozen tax thresholds make it worse?
Yes. The personal allowance and higher-rate threshold are held in cash terms until April 2028, so income rising with prices moves into higher bands without any real gain. High inflation therefore raises the effective tax rate as well as the cost of living.
Sources
Regulator references
- Bank of England on inflation · Bank of England · 2025The 2% target and how far actual inflation has run from it.Last verified: 2026-09-07
- Consumer price inflation, UK · Office for National Statistics · 2025The CPI series that drives statutory uprating.Last verified: 2026-09-07
- Income Tax rates and Personal Allowances · GOV.UK · 2025The band boundaries every figure in this post is calculated against.Last verified: 2026-09-07
Calculator unit tests · the assertions this page's worked example is checked against, and their last result
Changelog
- 2026-09-07 — initial publish (new format)
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Jordan Reeves
Founder of Talk Through Wealth. A software engineer for over a decade before turning to retirement planning, Jordan built the projection engine after watching family members get fragmented, country-by-country advice that never reconciled. He writes about retirement the way the engine computes it: month-by-month, lifetime-long, and skeptical of any rule of thumb that hasn't been run through the math.