Changes to the way pensions are calculated will cost many people thousands of pounds a year, reports The Times Online (28/11/2020)
From 2030 the retail prices index (RPI) measure that determines the rates of some pensions will be replaced with the consumer prices index including housing costs (CPIH) which has historically been about 0.8 percentage points lower.
The move is a blow to anyone who is either saving into or receiving an income from a Defined Benefit pension, where payments in retirement are dependent not on stock market returns, but a set formula linked to RPI. Anyone who bought an annuity — an income for life — that rises in line with RPI will also lose out.
Many Defined Benefit pensioners will suffer a reduction in lifetime benefits, with women (who live longer) and younger savers (who face years of less generous pensions from 2030) experiencing the greatest reduction, according to the Pensions Policy Institute.
Take someone who has an annual pension income of £15,000 a year linked to RPI. Over the course of a 30-year retirement, if RPI rose 2.8 per cent a year they would get a total income of £710,299. If it rose in line with CPIH at 2 per cent, over the same 30-year retirement they would get roughly £620,691.
Will it affect the state pension?
No. The state pension rises by 2.5 per cent in April in line with the government’s “triple-lock” promise. It goes up by CPI (which does not include owner-occupier housing costs), wage growth, or 2.5 per cent, whichever is higher.
Why is the measure changing?
Statisticians argue that CPIH is a more accurate and robust way of measuring changes in the cost of living.
Haven’t some pension schemes already moved to CPI?
Yes, most notably public sector pensions, which were changed from RPI to CPI in January 2011. Tesco’s pension fund switched in 2012, affecting about 170,000 people. British Airways has also stopped increasing its defined benefit pensions in line with RPI and will now do so on a discretionary basis, based on affordability.
How will it affect pension schemes?
Defined benefit pension schemes are in a deficit of £279.5 billion. The overall impact will depend on the investments they hold. Those with a heavy exposure to UK index-linked gilts could suffer a drop in the value of these investments from 2030, meaning they will need to find more cash to meet their pension promises.
The Pension Protection Fund, the government safety net for defined benefit pension savers whose companies go bust, estimates that the change will mean a £1 billion hit to its balance sheet.
On the plus side, where pension payments are linked to RPI, it will mean a reduction in pension scheme liabilities because pension benefits will rise more slowly.