8 July 2010 Last updated at 12:52 ET

Plan to change private pension inflation link

Future pension rises could be affected by the change

The government wants to change how some private sector pensions are calculated.

The proposals mean millions of people would be likely to see lower increases to their pensions in retirement.

Pensions minister Steve Webb said there were plans to link pension payments to the typically slower-growing Consumer Prices Index (CPI) measure of inflation instead of using the RPI.

Accountants KPMG said this could reduce UK private sector pension liabilities by 10% or about £100bn.

People in dormant and occupational schemes would be affected.

The existing system ties pension increases to the Retail Prices Index (RPI) which includes housing costs such as mortgage interest payments.

The CPI is typically lower - and over the past 20 years it has been higher than the RPI only three times.

KPMG also said the changes could lead to a "smallprint lottery", as individual schemes might have different legal rules.

Changes

In the Budget, Chancellor George Osborne said that most benefits and public sector pensions would be linked to the CPI - potentially saving the government millions of pounds.

In a written ministerial statement, Mr Webb - a Liberal Democrat - said that the same should be true of occupational pensions.

"The government believes the CPI provides a more appropriate measure of pension recipients' inflation experiences and is also consistent with the measure of inflation used by the Bank of England," he said.

"We believe, therefore, it is right to use the same index in determining increases for all occupational pensions and payments made by the Pension Protection Fund and Financial Assistance Scheme."

This would mean that some companies would immediately see some pressure taken off them with regards to their pension liabilities, and might choose to keep their pension schemes open.

But individuals would be likely to see that, in the future, their pension incomes grew more slowly.

During their time in opposition, the Conservatives argued that pensioners were the "forgotten victims" of the recession, with the inflation rate for the state pension falling behind the rising cost of necessities such as food.

Technicalities

Between a quarter and a half of all current occupational pension schemes could be affected by the change, according to estimates.

Yet, it would depend on the terms and conditions of each individual scheme as to how members were affected, according to Mike Smedley, pensions partner at KPMG.

Some would automatically see lower pension increases, whereas others might get rises in line with RPI or CPI.

"This looks like a sensible change which would align public and private sector pensions and generally reduce the burden on pension schemes," he said.

"But we urge the government to make the legislation apply equally to all schemes and avoid a smallprint lottery for schemes and their members depending on technicalities and details of the scheme's legal documents."

'Watering down'

The government was trying to prop up final salary pension schemes by reducing their costs, said Laith Khalaf, a pensions analyst for Hargreaves Lansdown.

But he added this meant "watering down" benefits for members.

"Ultimately however I do not believe there is a great appetite out there among employers to keep final salary schemes open," Mr Khalaf said.

"Rising life expectancy and volatile deficits have led to widespread closure of these schemes and will continue to do so.

"In both the public and private sector, final salary schemes are losing their golden sheen. We are all having to take more and more responsibility for our own retirement as the state and employers struggle to cope with an ageing population."