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RPI change bad news for pension savers

26 November 2020

Pension experts have warned that the Chancellor’s decision to stop using the retail prices index (RPI) measure of inflation in 2030 will spell bad news for pension savers, including lower transfer values.

On the same day that Chancellor Rishi Sunak unveiled his Spending Review, he also announced that RPI will be brought into line with the approach used in the Consumer Prices Index including housing costs (CPIH). It follows arguments by statisticians in recent years that the CPIH is a more accurate and robust way of measuring changes in the cost of living.

The government has previously calculated that axing the RPI would save around £90 billion, however pension savers are likely to bear the brunt of the cost. Compared to the CPIH, the RPI has overstated inflation by an average of 0.8% a year.

Tom Selby, senior analyst, AJ Bell, said: “Chancellor Rishi Sunak has pushed the effective abolition of the RPI inflation measure as far back as he can to ensure it is not ‘materially detrimental’ to holders of index-linked gilts.

“However, from 2030 onwards the message is unequivocal: if you are negatively impacted by this, tough. The Government is clear it will not provide any kind of compensation to those who lose out as a result of the downgrade in the value of RPI. While the average difference between RPI and CPIH might look small at 0.8 percentage points, over time that could lead to a retirement income worth thousands of pounds less.”

Steven Cameron, pensions director, Aegon, said that over a course of 30 years, this could equate to the value of pension 20% lower than under RPI increases. According to Cameron, someone whose initial pension is £10,000 would with a 3% compound increase each year be receiving £24,273 in 30 years’ time, but with the lower 2.2% increase this figure would fall to £19,209.

Cameron commented: “A technical change to the way the inflation index is calculated is an unlikely candidate for grabbing people’s attention. But if you’re one of the millions who receive an inflation protected pension from a defined benefit scheme or annuity, it could impact negatively on your pension income for the rest of your life.

“While the Government and its statisticians may correctly argue that CPIH is a more robust measure of actual increases in the cost of living, this is unlikely to appease those in defined benefit pensions who’ll see this as losing out on what they believed they were entitled to.”

Transfer and annuity values

And this won’t just affect those who are already retired, Cameron points out. “Anyone in a defined benefit pension considering taking advice on transferring to a defined contribution pension is likely to see the transfer value offered cut to reflect lower future increases had they stayed in the scheme.”

David Gibb, financial planner, Quilter, said there will be “winners and losers” as a result of the switch, but warned that the impact on markets, pension schemes and people’s personal finances could be “stark.”

Gibb said: “As pension schemes are, by definition, a long-term product, just a small tweak in the methodology for increasing payments can have a huge impact on the value of the pension. For now this has been kicked down the road and that should help give people time to plan appropriately. For those wishing to transfer to a defined contribution scheme, transfer values may fall in future as these are tied to the value of gilts. Annuities also have payments linked to RPI and future annuity prices may not be lower to reflect the lower level of expected future benefits.

“There is no disagreement about the need to ditch RPI as a measure of inflation. It has a number of statistical shortcomings, which means that it has at times overestimated or underestimated the true level of inflation. And when that change occurs there will be some who benefit. The move to CPIH will lower repayment rates for students across the UK and although commuting seems like a distant memory for many, rail fare hikes are linked to RPI so commuters could find their annual fare increase might not be quite so painful in the future.

“However, it is still within the power of government to simply change how these rates are calculated and keep them linked to RPI to keep money flowing to the Treasury.”                                 `

However, Nigel Peaple, director of policy and research, PLSA, expressed disappointment at the move, noting that it will have a “detrimental impact” on savers’ retirement incomes and on the assets of UK pension schemes.

Peaple said: “The change, which will reduce the value of pension schemes’ investments by an estimated £60bn, will also raise the risk of insolvency for employers as they seek to address the shortfall in funding of their workplace pension schemes.

“The PLSA has advocated for solutions which mitigate the enormous cost to schemes, employers and savers, either through one-off payments or by technical measures that better reflect the higher value under the current RPI measure. The Government says it will keep the occupational pensions sector under review. We will certainly continue to press our case against this deeply unfair decision.”

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