Reforming RPI will hit the incomes of savers across the country, with no sign of compensation.
There was plenty to be concerned about in last week’s Spending Review.
There’s no escaping the fact that we face some serious economic upheaval, and not just in the short term, as a result of the Covid-19 pandemic and the various financial measures introduced by the Government to help support people who are simply unable to work.
But as always with these statements, there are elements that perhaps don’t make the speech, or don’t make the initial headlines which have the potential to make a dramatic impact on the lives ‒ and incomes ‒ of ordinary people.
And in this case, the Government’s confirmation that it is doing away with the Retail Prices Index (RPI) measure of inflation could mean a hit of thousands of pounds a year for retirees across the country.
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Inflation-proof… sort of
There are all sorts of pensioners whose incomes in retirement are ‘inflation-proofed’, meaning they go up in line with the rate of inflation each year.
For some, it will be a defined benefit pension, also known as a final salary scheme, where your income is based on your salary during your years of service and your time with the business.
For others, it will be the annuity they have bought with their pension pots, guaranteeing their income for life, and which also increases each year by the rate of inflation.
It’s an important consideration for any saver. The money you have today will likely not be worth as much in 10 years' time. So having a pension income that combats inflation, that goes up every year ensuring that you don’t have to make do with less is a powerful selling point.
After all, it’s part of the reason that the State Pension triple lock has been so successful, to the point that it’s now apparently impossible to do away with it.
The trouble is that there’s more than one measurement of inflation (which the Government always uses to its advantage). And that’s where the reform of the RPI comes in.
A flawed measurement
An awful lot of pension schemes and annuities that increase in line with inflation use the RPI as their chosen measurement, which is why the removal of it as a measurement is something of a concern.
First, though, it’s worth accepting that changing RPI is understandable.
The bods at the Office for National Statistics have warned that it is a flawed way of tracking inflation for a long time.
In fact, back in 2018, it said: “Overall, RPI is a very poor measure of general inflation, at times greatly overestimating and at other times underestimating changes in prices and how these changes are experienced.”
There are all sorts of different reasons why it isn’t very good, ranging from the formulas used to the way that it treats housing costs, which mean it is overly influenced by house prices and interest rates.
So tweaking it, at the very least, is no bad thing.
And that’s what the Government is doing, reforming it to bring it into line with the Consumer Prices Index including housing (CPIH) which is considered far more accurate and useful.
But there’s no denying that the move will hurt an awful lot of pensioners.
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What difference will it make?
One of the reasons RPI is being ditched is because it often overstates inflation. Over the last five years, it has tracked at about 0.8% a year above CPIH.
So this reform means that those inflation-linked pensions will not increase by as much as before.
On the face of it that doesn’t sound like much really. But this is a pension we’re talking about, something that ‒ if you’re fortunate ‒ you’ll be receiving for decades.
Let’s look at an example from Aegon.
Let’s say I have a £10,000 pension pot. If it was increasing by 3% on a compound basis each year, then in 30 years' time I’d be receiving £24,273 a year.
But if it was only increasing by 2.2% instead, then I’d receive £19,209 after three decades.
And it’s not like this is only going to impact a small number of people either.
As many as 10 million savers are believed to have pension incomes linked to the RPI, with the Association of British Insurers suggesting it will cost pensioners and investors the small sum of £96 billion.
Ouch.
Little wonder that Ian Mills, partner at Barnett Waddingham has described it as “arguably the biggest and cleverest stealth tax of all time”, given it will save the Treasury around £2 billion a year in interest payments on index-linked gilts.
And it will be the many innocent pension savers who are left counting the cost. It's one thing to scrap the RPI as a genuine measurement of inflation, used by the ONS.
But it's quite another to simply do away with it entirely, leaving savers out of pocket through no fault of their own.
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