Pensions inflation proofing baffles public, survey says

Money in a wallet Changes to the way inflation is calculated will have a big effect on people's pensions.

Most people do not understand the government's changes to the inflation-proofing of pensions, a survey says.

State and public pension schemes are swapping from the retail prices index (RPI) to the slower growing consumer prices index (CPI) to uprate payments.

The government also wants private sector pension schemes to do the same.

But a survey for pension consultants Aon Hewitt suggests only a minority of adults appreciate how much this will devalue their pensions.

The survey, conducted by the polling organisation YouGov, found that:

  • Only 65% of the 2,117 adults polled had heard of both RPI and CPI.
  • Of the 1,385 adults who said they were aware of both RPI and CPI, 59% said they did not know the difference between the two.
  • 58% of the 2,117 respondents said it was likely or very likely that a change in the way inflation was calculated would affect their income in retirement.
  • But only 40% of the 2,117 were aware that the government's plans would in fact do this.

Aon Hewitt warned it might take "some years" before people understood the effect the change would have on their own pensions.

"The move from RPI to CPI is this government's equivalent of linking the basic state pension to prices rather than earnings, as occurred back in 1980," said Lynda Whitney at Aon Hewitt.

"This was a technical move which it took many years for the impact to really be understood.

"If the basic state pension had remained linked to earnings it would have been worth £158.60 not £97.65 by April 2010," she said.

Big effect

The consumer prices index generally rises each year by about 0.7 percentage points less than the retail prices index.

Thus pensions are likely to grow more slowly in future than would otherwise have been the case.

This will have a big cumulative effect over time.

"In the first year £1,000 of pension might increase to £1,037 with RPI but only £1,030 with CPI," said Aon Hewitt.

"However after a typical retirement of 25 years £1,000 of pension could grow to £2,480 with RPI and only £2,094 with CPI."

Rule changes?

Pension experts have calculated that introducing this change for the state pension, and also the big public sector pension schemes, could cut their underlying costs by as much as 10%.

That would mean a huge saving for the government.

It is still uncertain if the government will legislate to push through similar changes to private sector pension schemes.

Most have a link to the RPI "hard-wired" into their rules for the uprating of pensions in payment.

But for the uprating of deferred pensions - pensions owed to people who have left the company but who not yet reached retirement age - many schemes rules simply adopt whichever method the government recommends.

Despite the fact that the way CPI is calculated means it usually grows more slowly than RPI, this is not a consistent effect.

Figures published each month by the Office for National Statistics show that CPI has in fact been higher than RPI in 22 separate months since January 1997.

This was particularly the case during 2009 when falling interest rates meant that RPI, which takes into account mortgage interest payments, grew more slowly than CPI, which does not include them.

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