A technical change to the way the inflation index is calculated, as announced alongside the Spending Review, is an unlikely candidate for grabbing people’s attention.
But if you’re one of the millions who receive an inflation protected pension from a defined benefit scheme or annuity, it could impact negatively on your pension income for the rest of your life. In recent years, the Government and its statistical teams have been gradually moving away from calculating inflation using the Retail Prices Index (RPI) and have been publishing the Consumer Prices Index (CPI) and an alternative including Housing Costs referred to as CPIH which it believes is a more accurate way of assessing changes in the cost of living.
For example, the triple lock increases to the state pension are the highest of earnings growth, 2.5 per cent or price inflation as calculated using CPIH. Today’s announcement means from 2030, the RPI will be based on the approach currently employed within CPIH.
Over the last 5 years, CPIH year on year increases have been on average 0.8 per cent lower than RPI. If this continues, someone who is already receiving or was expecting to receive increases in their defined benefit pension in line with the RPI, which will in future mirror CPIH increases might receive 0.8 per cent less of an increase in future years. With people living longer, a pension can last for 30 years and while 0.8 per cent might not seem like much, over 30 years it can make a big difference.
For example, someone whose initial pension is £10,000 would with a 3 per cent compound increase each year be receiving £24,273 in 30 years’ time, but with 2.2 per cent increases, that would be £19,209 or a fifth less.
| 12 months increase as at: | RPI | CPIH | Shortfall |
| Oct 2020 | 1.3% | 0.9% | 0.4% |
| Oct 2019 | 2.1% | 1.5% | 0.6% |
| Oct 2018 | 3.3% | 2.2% | 1.1% |
| Oct 2017 | 4% | 2.8% | 1.2% |
| Oct 2016 | 2% | 1.3% | 0.7% |
| Average shortfall | 0.8% |
While the Government and its statisticians may correctly argue that CPIH is a more robust measure of actual increases in the cost of living, this is unlikely to appease those in defined benefit pensions who’ll see this as losing out on what they believed they were entitled to. And this won’t just affect those who are already retired. Anyone in a defined benefit pension considering taking advice on transferring to a defined contribution pension is likely to see the transfer value offered cut to reflect lower future increases had they stayed in the scheme.
