Private sector workers with final salary pensions could see their retirement incomes cut, under plans to link pension payments to the Consumer Prices Index (CPI) measure of inflation.
Currently, the Retail Prices Index (RPI) is used to calculate payouts for final salary schemes both in the public and private sectors. RPI is usually the faster-growing measure of inflation partly because, unlike CPI, it takes into account housing costs such as mortgage interest payments.
In last month’s Emergency Budget, Chancellor of the Exchequer George Osborne announced that public sector pension indexation would change. In future, CPI will take the place of RPI when most state benefits and pensions are calculated, meaning the rate at which payouts increase is likely to be reduced.
Private pensions and CPI
Now Liberal Democrat pensions minister Steve Webb has said the same should apply to private pension schemes held by employees, writing in a statement: ‘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.’
Linking public sector pensions to CPI instead of RPI could save the government millions of pounds, while private sector schemes that adopt CPI indexation also stand to make significant savings.
However, pensioners themselves will probably see their retirement incomes grow more slowly as a result of the change – which means the move is likely to be very controversial among consumers.
Pension terms and conditions
While some private sector pensions could easily adopt CPI indexation, not all will be able to do so. The individual terms and conditions of particular pension schemes may mean it is difficult for companies to abandon RPI indexation.
In turn, this could lead to the establishment of a ‘pot luck’ pensions system, where some consumers benefit from swifter payment increases than other thanks to the small print in complex legal documents.
Pensions experts have also pointed out that this move may help to keep final salary pension schemes afloat for longer, even though it is widely believed that rising life expectancies and large deficits must lead to their eventual closure.
Planning your retirement
If you’re yet to start a pension and don’t know where to begin, read the Which? Planning your retirement advice guide. It explains the different options available to anyone looking to save for retirement, and reveals how much money you’ll need to put away if you want to live comfortably after you give up working.
You may also be interested in our review of Self Invested Personal Pensions (SIPPs). It will help you decide whether a SIPP is for you, as well as compare and contrast the features and costs of different schemes.
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