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Long-awaited reform

Private pensions to be hit by change to inflation measure

pension pot

Savers will see their investments fall in value

Private pension holders and those on benefits will among be the losers while students and rail passengers will be the gainers if, as expected, Rishi Sunak confirms a change in the measure of inflation in Wednesday’s Spending Review.

The Chancellor is tipped to scrap the higher Retail Prices Index (RPI) for the Consumer Prices Index plus housing costs (CPIH) measure which is generally about 0.8% lower. RPI last month was 1.3% while CPIH stood at 0.9%.

The long-anticipated change would save the Treasury around £2 billion a year on interest payments for index-linked gilts.

However, it could cause havoc in the savings industry because RPI-linked increases are written into millions of financial services contracts. 


Tom Selby, senior analyst at AJ Bell, says: “There are, for example, defined benefit (DB) schemes where scheme rules require members’ retirement incomes to rise in line with RPI.

“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.”

Switching to the lower CPIH will mean investments or pension incomes will grow more slowly than they would if they were linked to RPI.

“Estimates published earlier this year by the Association of British Insurers (ABI) suggest the overall negative impact of a switch from RPI to CPIH could be somewhere north of £100 billion,” said Mr Selby.

“The hit would not come overnight, however, but rather through a slow grinding down of the real value of people’s pensions and investments.

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“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.”

However, ditching RPI could be good news for some young people and commuters as rail fare increases and student loan repayments have been linked to RPI and would therefore be lower under CPIH. 

Mr Selby says: 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.

“Moving away from RPI to CPIH could precipitate an end to this approach and provide a much-needed boost for indebted students and rail passengers.”

The consultation on making the change was launched in the Budget on 11 March. It was scheduled to close on 22 April, but owing to the coronavirus (COVID-19) pandemic, the consultation period was extended to 21 August.

RPI could be phased out between 2025 and 2030.

SEE UPDATE: Chancellor confirms change… but not yet

Case study

Someone who has a £20,000 annual pension which is linked to RPI.

Over the course of a 30-year retirement, if RPI rose by 2.8% a year they would have received a total income of £947,000. 

However, if instead it rose in line with CPIH at 2%, 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.

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