The government has confirmed plans to change RPI (Retail Prices Index) to make it more like CPIH (Consumer Prices Index including owner occupiers’ housing costs). The change will be delayed until at least 2030, when the final set of index-linked gilts with an RPI promise will mature. The ABI estimates that the move could cost investors and pensioners £122 billion. Pensioners will be hit particularly hard.
The Pensions Policy Institute found that nearly two thirds of private sector DB schemes currently uprate pension benefits in line with RPI. It also calculated that the shift in 2030 would cost the average man £6,000 and the average woman £8,000. It’s not just today’s pensioners who will lose out, but workers in final salary schemes too.
On the flip side, this will put a stop to ‘inflation shopping’ where the government links expenses (like benefits and pensions) to lower CPI, and income-generators to higher RPI (like car tax and student loans).
Sarah Coles, personal finance analyst, Hargreaves Lansdown:
“This is a horrible blow for pensioners, who will pay the lion’s share of the eye-watering cost of this move. The government will change the way RPI is calculated to make it more like CPIH – which is likely to make it lower. This will mean any pensioners with an RPI-linked income will see it rise slower in future.
It will stop the government from going inflation shopping – linking things we pay the government to higher RPI, and government spending to lower CPI. However, there was an easier way to do this: the government could have simply done the right thing and used a single inflation measure, without the need to take the money out of the pockets of pensioners.”
Phil Warner, head of regulatory advice and policy’, Hargreaves Lansdown:
“We believed that RPI should have continued to be published in its existing form. Not because it’s accurate, or correct, but because pensioners should continue to receive the pension income they have paid for and it is right for the government to maintain trust in pensions.”
Who will pay the price?
Final salary pension scheme members. Nearly two thirds of private sector defined benefit schemes link rises in pension income directly to RPI, so switching to a lower measure of RPI could mean lower future incomes in retirement. This doesn’t just affect today’s retirees, but millions of workers paying into these schemes too. However, this is a contentious issue, so it may trigger legal challenges – which makes the final impact difficult to assess.
Annuity holders with RPI guarantees. If you bought an index-linked annuity, changes to the index are likely to see your retirement income rise more slowly.
Bond investors. If you have index-linked bonds in your investment portfolio, the change will mean lower index-linking (assuming your bonds are linked to RPI). Their value is also likely to fall, as investors see them as less attractive.
What’s wrong with RPI?
The problem with RPI became clear around 2010 when the range of clothing in the basket of goods used to calculate RPI was expanded to make it more comparable through the seasons. As a result, there was a spike in clothes price inflation that the ONS has called ‘implausible’. It comes down to how RPI averages things out, which tends to exaggerate rises.
RPI has been dropped as an official inflation measure, and just kept as a legacy measure because so many things are linked to it throughout the economy.
CPI was introduced as a European measure, and CPIH is a variation that factored in the cost of housing. It has since become the government’s measure of choice. CPIH calculates its averages differently to RPI, so tends to be consistently lower. Typically it’s 1% lower than RPI – this difference has become known as ‘The Wedge’.
The consultation looked at aligning the two, so RPI more closely matches the methodology of CPIH.
What is linked to RPI?
Final salary pension payments.
Income from index-linked annuities.
Income from some index-linked bonds.
Regulated rail fare rises (and wage negotiations for rail workers).
Mobile phone tariff price rises (the maximum rise allowed without triggering your right to leave the contract early).
Vehicle excise duty (better known as car tax).
Air passenger duty rises.
Tobacco and alcohol duty rises.
Interest on student loans.