Government plans to align the Retail Price Index (RPI) with the Consumer Price Index (CPIH) could wipe £80 billion off pension assets, the Pensions and Lifetime Savings Association (PLSA) warned.
The Government and the UK Statistics Authority first launched a consultation in March 2020, with a view to whether its proposals could be implemented before 2030.
While the PLSA said it recognises that RPI is a “flawed measure” of inflation and supports plans to develop a new more robust measure, aligning the two measures will significantly impact defined benefit pension schemes because the RPI rate is structurally higher than CPIH by around 1% per year, the industry body said.
With an average £470 billion currently invested in index-linked bonds, pension funds could see their value reduced by £60 billion if changes are made by 2030 and £80 billion if done by 2025. Employers will have to make up the shortfall through increased contributions, the PLSA said.
The changes will also negatively impact individual pension savers, who stand to lose an average 4-9% of their total lifetime pension income. This means a man aged 65 in 2020 could see a drop in his yearly average pension income by as much as 17% if changes are made in 2025, while a woman of the same age could experience a yearly income drop of 19%.
The PLSA said the problem could be solved by adjusting index-linked gilts from RPI to CPIH, including a transparently calculated adjustment reflecting the expected long term average future income of RPI over the new inflation measure, in what is known as “CPIH + a spread”.
In addition, the PLSA said the government should implement the changes as close to 2030 as possible, allowing for a working group to be established to help with the transition and provide investors in index-linked gilts enough time to prepare for the change.
Tiffany Tsang, senior policy lead, LGPS and DB, PLSA, said: “The decision to develop a more robust measure for inflation is the right one but the proposed methodology risks billions of pounds in pension assets. Pension schemes have made RPI-linked investments in good faith, and under the guidance of the regulators, to prudently fund pension benefits. They should not face short-falls as a result of the changes.
“Moreover, the new method of calculating how much to increase pensions each year to take account of inflation could result in cuts to people’s pensions of up to 9% over a lifetime. This will make it less likely they will have an adequate income in retirement.
“In its plans to reform the inflation measure, we strongly urge the Government to mitigate the detrimental impact this change will have on holders of index-linked gilts and find an equitable transition away from RPI.”
Commenting on the government’s plans, AJ Bell senior analyst Tom Selby said the move would represent a “stealth cut” to people’s hard-earned retirement pots.
Selby said: “If these contracts were ripped up and RPI replaced with CPIH – which tends to be lower – it would effectively represent a stealth cut to people’s hard-earned retirement pots. Any annuities linked to RPI would also be worth less if this link was downgraded to the CPIH inflation measure.
“Anyone invested in index-linked gilts – including individuals and pension funds – would also see the value of their holdings tumble if the Government applied a blanket overnight switch from RPI to CPIH.
“The big question the Government needs to answer is the extent to which it will mitigate any negative impact on people with pensions and investments explicitly linked to RPI. One option in this regard would be to maintain a notional RPI which these contracts could then adopt, although this might mean RPI remains part of the system for decades.”
