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Pension cuts for up to 12 million

Pension cuts for up to 12 million

From next year the government will require final salary pensions to be increased in line with CPI rather than RPI, they announced.

The announcement extends to the private sector the treatment already being meted out to the public sector and state pensions. Up to 12 million final salary members now face the prospect of a smaller pension. Laith Khalaf, Pensions Analyst: ‘Final salary pensions are facing cuts in both the public and private sector as the weight of the pension promises made to workers has proved too great. Millions will have to fill holes in their retirement income by making additional private savings of their own.'

What is happening?
Final salary schemes are currently required to increase the pensions they pay in line with RPI, from next year this will change to CPI. Pre-retirement pensions will also be affected. When you switch jobs and leave a final salary scheme you are entitled to a preserved pension. Until now the government have required that these preserved pensions are revalued in line with RPI each year until retirement, from now on they will require revaluation in line with CPI.

These measures will reduce the liabilities of final salary schemes but at the cost of the benefits enjoyed by their members.

Why is this happening?
The government are well-intentioned, they are trying to prop up final salary schemes by reducing their liabilities. However they are fighting a vertical battle: employers no longer have an appetite to provide final salary pensions as a result of wildly fluctuating deficits, increasing life expectancy and more recently the prospect of interference from Brussels. Nine out of ten final salary schemes intend to axe or reduce benefits for members according to a recent survey by PricewaterhouseCoopers.

What kind of effect will this have on pensioner incomes?
Based on historic rates of RPI and CPI, a pensioner retiring now on a £5,000 final salary pension could expect an income of £9,737 in 20 years if it was uprated in line with RPI; it would be worth £8,497 (13% less) if uprated in line with CPI. Over that 20 year period, the pensioner would have missed out on £10,367 in income in total. The longer the pensioner lives, the worse the effects will be.

The effect on younger members with preserved pensions is more dramatic because their pension is revalued by less until retirement as well as being increased by less after retirement. For instance, a 40 year old with a £5,000 preserved final salary pension today could have expected to receive a pension of £11,603 from age 65 if uprated in line with RPI; this can be expected to fall to £9,769 with CPI uprating. Moreover the CPI uprating continues once the pension is in payment. By the age of 85 the member could be receiving an income of £17,070 compared with £23,403 if uprated by RPI. In the course of the 20 years over which his pension was being paid, he would lose out on £77,077 in income in total.

RPI vs CPI
Since 1988 RPI has on average run at 3.6% compared to CPI at 2.8%. The government claim that CPI is a more indicative measure of pensioner inflation compared to RPI because it does not include mortgage interest costs, which affect few pensioners. However neither does CPI include council tax, which accounts for a higher proportion of pensioners' expenditure than those of working age; it accounts for 7% of over 75s' expenditure compared to 3% for those under 50 according to the ONS. In truth neither CPI nor RPI is a pinpoint measure of pensioner inflation, which is disproportionately affected by increases in food, energy bills and council tax. The change from RPI to CPI will also impinge on pre-retirees with preserved pensions, who do have exposure to mortgage interest costs.