Chancellor Rishi Sunak’s rumoured plan to ditch Retail Prices Index (RPI) inflation measure in tomorrow’s spending review could wipe around 0.8 per cent a year off payment increases.
The Chancellor is rumoured to be planning to phase out RPI between 2025 and 2030, and replace it with the alternative Consumer Prices Index measure (CPIH).
Previous estimates from the Association of British Insurers published this year said this could wipe £122bn from the value of pensions and investments.
Investors in index-linked gilts, defined benefit pension (DB) scheme members and annuity holders could be among those hit if RPI is abolished; while those with student loans and rail passengers stand to benefit.
AJ Bell senior analyst Tom Selby says: “Proposals to abolish the RPI inflation measure have barely created a ripple in 2020 but risk causing colossal damage to people’s pensions and investments. This is because, as things stand, RPI-linked increases are written into millions of financial services contracts.
“Annuities have also been sold on the promise of RPI protection, while index-linked gilts, which are held by huge numbers of investors either individually or via their pensions, are also pegged to RPI inflation.
“If these contracts are to effectively be torn up and RPI replaced with CPIH, millions of savers and investors stand to lose out as a result.
“Because CPIH tends to be around 0.8 percentage point lower than RPI, over time investments or pension incomes linked to CPIH will grow more slowly than they would if they were linked to RPI.
“The key question now is whether the Chancellor will provide any sort of easement to protect existing contracts. One option would be for the ONS to keep publishing RPI so companies can continue to honour contracts written prior to the change.”
Ditching RPI could be good news for some young people and commuters, however. The Government has doggedly, and some would say cynically, continued to link things like rail fare increases and student loan repayments to RPI, ensuring a quiet and creeping boost to Treasury coffers.
Conversely, the state pension, benefit payments and tax thresholds have been linked to the lower CPI measure, leading to accusations of ‘index shopping’ by successive administrations.
How swapping RPI with CPIH could affect someone with a £20,000 a year pension
The impact of linking people’s retirement incomes to a lower inflation measure will be felt over the course of decades.
For someone with a £20,000 annual pension which is linked to RPI, over the course of a 30-year retirement, if RPI rose by 2.8 per cent a year they would have received a total income of £947,000.
However, if instead it rose in line with CPIH at 2 per cent, over the same 30-year retirement they would receive total income of roughly £828,000.
This means a simple switch from RPI to CPIH could cost someone in this position £119,000 in lost retirement income.”