How scrapping the Retail Prices Index could impact your pensions

One of the main challenges facing any saver or investor is to ensure their money retains its value in real terms. If you’d invested £10,000 in 1999, you’d have needed your money to be worth £17,460 in 2019 just to keep pace with rises in the cost of living.

In recent years, even keeping pace with inflation has been tough in traditional savings accounts. Many instant access accounts now pay just 0.1% or lower – that’s £10 in interest for every £10,000 you invest.

Now, a change in the way inflation is measured could have an even greater impact on your financial security.

Treasury consulting on replacing RPI with CPIH

In recent months, the Treasury has been consulting on the future of the Retail Prices Index (RPI), one of the common measures of inflation in the UK. While this may seem like a minor issue on the surface, scrapping the RPI could have enormous ramifications for anyone with savings, investments or pensions linked to what has become a widely discredited inflation measure.

Indeed, the Association of British Insurers (ABI) has claimed plans to bring the Retail Index Price (RPI) into line with the Office for National Statistics preferred measure of inflation could cost pensioners and savers £122 billion.

Flaws in the way the RPI is calculated have led the government to consult on scrapping the measure altogether, and replace it with the Consumer Prices Index (CPI), plus ‘the cost of housing services associated with owning, maintaining and living in one’s own home’ to create a new measure, CPIH.

Why this matters to you

The issue with replacing the RPI (due to take effect between 2025 and 2030) is that RPI tends to be higher than the CPI (and likely the new CPIH) – on average by 1% over the last ten years.

However, the RPI is used to calculate the annual increases in many Defined Benefit/Final Salary pensions. If you have a Final Salary pension, the scheme rules may enshrine RPI increases. Replacing an RPI increase with a CPIH increase could see your pension rise more slowly after the implementation of these reforms.

The Pension and Lifetime Savings Association (PLSA) says that a man aged 65 in 2020 could see a drop in his annual average Final Salary pension income by up to 17% if the changes are made in 2025 and a woman of the same age could see her Final Salary income fall by up to 19% a year.

In addition, the RPI is also used to calculate returns on index-linked gilts – government bonds which track inflation which are held as safe investments by pension funds, ISAs, and life insurance funds.

Pension schemes currently invest an estimated £470 billion in index-linked bonds. The Pension and Lifetime Savings Association (PLSA) cites analysis by the Pensions Policy Institute (PPI) that estimated the switch to CPIH without mitigating steps would reduce the value of these investments by £60 billion if alignment occurred in 2030 and by £80 billion if aligned in 2025.

ABI members have estimated that implementing the changes in 2025 could leave savers worse off by up to £122 billion, or in 2030 by £96 billion.

ABI calls for compensation for those affected by the change

If the Treasury decide to replace the RPI with CPIH, this is likely to happen between 2025 and 2030.

The ABI is calling for the latest possible implementation date to reduce the impact on savers and is recommending compensation for those affected. It says people with life insurance, pensions policyholders and Defined Benefit pension scheme members will be most affected.

One option that has been suggested is to continue publishing a ‘ghost’ RPI measure. This would mean that existing contracts, such as Final Salary pension schemes, could continue to be honoured. However, this would mean retaining an inflation measure for decades that most statisticians accept is inaccurate.

Get in touch

If you have any investments or benefits linked to RPI, it’s likely you’ll need to adjust your plans to reflect a potentially material downgrade in value if the Treasury decides to replace RPI with CPIH.

If you have any questions about this, or it’s time to review your arrangements, please get in touch. Email or call us on 01454 416653.

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