Work all your life, then get an extra £2.40 a week

With inflation higher than it seems, you get a raw deal as you get older. Find out how to fight back in five simple steps.

Official rates of inflation appear to have very little to do with the real purchasing power of your income. This is especially true if you've already retired.

As of last month, the government's favoured measure of inflation, the consumer prices index (CPI) - which excludes mortgage interest payments - stood at 1.1%. This means the price of an assortment of goods and services is now 1.1% higher than it was 12 months ago. Well, that's the theory anyway.

But, on the flip side, the retail prices index (RPI) - which includes mortgage costs - stands at -1.4%. This rate indicates prices are actually 1.4% lower than they were a year ago. In other words, we're in the middle of a period of deflation.

A double whammy

But if you have already reached state pension age, all this is a double whammy of bad news. Firstly, income provided by the basic state pension is linked to increases in the RPI. So when the RPI is falling - as it is now - you'll suffer lower income growth. So your income will increase at a slower pace than before.

You could argue that lower income growth is OK, if the price of goods is also lower than it was. But that leads me onto my second point...

As a pensioner, you probably feel the effects of inflation far more keenly than most working people. That's because the cost of the items you usually spend the most money on - such as food, fuel and council tax - are rising far beyond the official rate of inflation.

So what you end up with is an income which seems smaller as the price of items you tend to buy are far more expensive.

You don't need to be a mathematical genius to see these figures just don't add up. It's truly bizarre that the RPI is used to determine the increase in a pensioner's income when RPI relates to a basket of goods which has very little in common with pensioner spending.

Good news? Not really...

So because the RPI is negative, you'll get a smaller state pension next year?

Thankfully, no.

Increases to the state pension take place every April. They're based on the change in the RPI over the 12 month period to the end of the previous September. But when the RPI is negative, the government guarantees an increase of at least 2.5%, regardless of the inflation rate.

Things could be worse, but I think this rise will provide very little comfort. Let's take a look at things in cash terms. This tax year, the basic state pension for a single person is £95.25 per week (or £152.30 per week for a couple). From the 6 April 2010, it will rise to £97.65 or, in other words, an extra £2.40 per week or 34p a day.

Think about it: £2.40 is barely enough to buy the grandkids a packet of Werther's Originals, let alone fight rapidly rising bills. Remember, two huge costs facing pensioners - council tax and utilities - will probably rise above 2.5% next year. This will leave many pensioners in a worse financial position overall than they're in now. And if pensioner inflation gathers pace next year, budgets will be stretched even further.

Do you think the basic state pension is enough to live on? Watch our recent video on this topic to find out what other people think! Watch the video now

How can you fight back?

The government has said it plans to re-instate the link between the state pension and the increase in average earnings, rather than prices. Earnings normally rise at a faster pace than the RPI which should be beneficial to you. But the change won't come into force until 2012 at the earliest - and could be delayed as late as 2015.

The Conservatives have also committed to re-instating this link, but haven't given a timeframe.

All of which is not much good for pensioners today.

If you're retired I'm afraid, in the absence of any real help from the government, it's down to you to make the most of the income you have. Here's my quick five-point plan:

1. Learn to live on a budget

Take a look at these articles for top tips on budgeting and keeping your household bills in check:

For utilities read Five ways to slash your energy bills and don't forget to hunt down the cheapest tariff using our gas and electricity comparison engine.
Check out How to save money in every room of your home and Seven easy ways to cut your living costs.
Learn how to cutback your grocery bill by reading Ten ways to cut your food bill.
And finally, for advice on learning how to live on a budget, read How to budget in five simple steps and Extra cash for pensioners.

2. Heat your home for less

If you're 60 or over you may get a Winter Fuel Payment to help cover your heating costs. You could get between £125 and £400 depending on your circumstances. Find out how to claim here. If you need help with your heating bills or to improve insulation in your home and you're over 60 and on benefits, you may be eligible for a Warm Front grant. And if you're over 70, you can get an cavity wall insulation installed for free, regardless of whether or not you receive benefits. Use the Energy Saving Trust website to search for energy saving grants.

3. Find out if you qualify for the Pension Credit

The Pension Credit is a means-tested entitlement which guarantees a minimum level of income above state pension for everyone aged 60 and over. If you're single you'll get at least £130 per week, while couples will get £198.45. If you're over 65 and you have some savings you may benefit from even more. Find out more here.

4. Claim all the benefits you're entitled to

If you qualify for the Pension Credit you may also be eligible for other benefits including Housing Benefit, Council Tax Benefit, and free NHS dental treatment. You can find out more from the Direct.Gov website.

5. Make the most of any other pensions, savings and investments

Spend your resources carefully now to avoid going short later on. You should treat your assets as a reserve to see you through your retirement. If you want to keep things simple, you can put your cash in a high-interest savings account which you can draw on as needed. It's also a good idea to discuss your income needs with a good independent financial adviser.

Got a question about your pension, or about pensions in general? Why not ask other lovemoney.com readers for help or advice on our Q&A boards?

Check out more retirement and pensions articles at lovemoney.com

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