Changing the private sector pension inflation link

The Government is planning to index private sector defined benefit pension increases to the Consumer Prices Index (CPI) measure of price inflation.

These pension schemes are currently increased each year in line with the Retail Prices Index (RPI), which is typically higher than CPI. Over the past twelve months, CPI has been 3.4% with RPI at 5.1%.

Pensions Minister Steve Webb made the announcement in a statement, saying:

“The Government believes the CPI provides a more appropriate measure of pension recipients’ inflation experiences and is also consistent with the measure of inflation used by the Bank of England.

“We believe, therefore, it is right to use the same index in determining increases for all occupational pensions and payments made by the Pension Protection Fund and Financial Assistance Scheme.”

He might have a point.

The RPI measure of price inflation includes the cost of mortgage interest payments; something that those in retirement do not typically need to meet. However, price inflation in retirement is usually higher than it is for people still working, as the goods and services consumed by older people tend to increase in value at a faster rate.

The Trades Union Congress (TUC) is unhappy with the plans, pointing out that if this link had been in place for the past twenty years, pension payments today would be 14% lower than if they had been linked to RPI.

One impact of this move is that it will reduce the cost of funding pension provision. KMPG has estimated that the move will reduce UK private sector pension liabilities by 10% or about £100bn.

This could result in a temporary reprieve for those private sector defined benefit schemes that remain open to new members. These expensive schemes are closing on a regular basis, due to the higher cost of providing benefits because of longer life expectancy, lower investment returns and more stringent requirements.

Changes to your own pension benefits will depend on your individual scheme, so it is important to engage with the scheme trustees throughout the process and understand what impact it will have on your income in retirement.

Do speak to us if you have any questions about the impact this change could have on your retirement planning and what steps you will need to take to plan for any shortfall as a result.