COLOSSAL DAMAGE
Rishi Sunak confirms £96billion blow for pensions and investments
CHANCELLOR Rishi Sunak has today confirmed a change to how pensions and investments are calculated that could cost savers up to £96billion.
The announcement was left out of the government's official Spending Review, but instead snuck out in some background documents.
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The documents state that the Retail Price Index (RPI) - one of the ways that we calculate inflation increases for financial products - will be scrapped after 2030.
Over six million Brits will be affected by the move, with pensions savers and investors hardest hit, losing out on billions of pounds.
Andrew Megson, executive chairman at My Pension Expert, said: “All eyes have been on the Spending Review and how the Chancellor plans to recoup some of the money spent on the COVID-19 rescue packages.
"However, away from the limelight of his speech, it has been confirmed that the RPI will be reformed from 2030 to align with the CPIH."
What is RPI and how does it affect my finances?
The UK has several main methods to measure inflation including RPI, the Consumer Prices Index (CPI) and the Consumer Prices Index including owner occupiers' housing costs (CPIH).
Because the measures are calculated differently, CPIH tends to be about 0.8% lower than RPI.
Different financial products use different measures and which one is chosen can have a significant impact on your finances.
Scrapping RPI - the winners and losers
Sarah Coles, personal finance analyst at Hargreaves Lansdown lays out the biggest winners and losers from a switch to CPI
The winners
- People who travel by train. Regulated rail fare rises (and wage negotiations for rail workers) are linked to RPI.
- Mobile phone users. Mobile phone tariff price rises, i.e. the maximum rise allowed without triggering your right to leave the contract early, are pegged to RPI.
- Car owners.Vehicle excise duty (better known as car tax) is based on RPI.
- Holidaymakers. Air passenger duty rises are based on RPI.
- Drinkers and smokers. Tobacco and alcohol duty rises are RPI-linked.
- Graduates. Interest on student loans is hooked to RPI.
The losers
- 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 CPIH could mean lower future incomes in retirement.
- 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.
This already started to happen as the markets speculated about the change.
The government itself uses the measures in lots of different ways - often linking the things we pay for, such as rail prices and alcohol duty, to the higher RPI measure.
Tom Selby, senior analyst at AJ Bell, said: “The Government has doggedly, and some would say cynically, continued to link things like rail fare increases and student loan repayments to RPI, ensuring a quiet and creeping boost to Treasury coffers."
At the same time, the Treasury tends to link its own spending, for instance on benefits and the state pension, to the lower CPIH calculations.
On paper, that means scrapping the RPI looks like good news, as the cost of everyday items such as train tickets, flight tax, car tax, tobacco and alcohol duty and mobile phone tariffs should all rise more slowly.
But experts are warning that there are significant costs associated with making the switch and that pensions savers will bear the majority of them.
The National Statistician, Professor Sir Ian Diamond, said: “The RPI is not fit for purpose and we strongly discourage its use."
How much will pensions lose if RPI is axed?
The government has previously calculated that it would save around £90billion from axing the RPI, this takes into account the amount that it will save on pensions and investments as well as the amount it will lose from consumer spending.
Sarah Coles, personal finance specialist at Hargreaves Lansdown said: “This is a horrible blow for pensioners, who will pay the lion’s share of the eye-watering cost of this move."
How swapping RPI with CPIH could affect your pension
AJ Bell sets out how a switch from RPI to CPIH will affect someone with a pension worth £20,000 per year
“The impact of linking people’s retirement incomes to a lower inflation measure will be felt over the course of decades.
“Take 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.”
But experts have calculated that the cost to pensions could be significantly higher.
Estimates published earlier this year by the Association of British Insurers (ABI) suggest the overall negative impact of a switch from RPI to CPIH in 2030 would be £96billion.
The hardest hit will be anyone who has a final-salary pension or who has bought an annuity for retirement. These are usually calculated using RPI, which means payments will rise more slowly.
The Pensions Policy Institute has calculated that the move would cost each male, final salary, pensioner £6,000
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Women will be even worse off, losing £8,000 each as the change takes place in 2030.
Investors of all kinds will also be impacted if they have index-linked bonds (gilts) that have used RPI - a common feature of many personal and workplace pensions, as well as investment ISAs.
Selby said: “Proposals to abolish the RPI inflation measure risk causing colossal damage to people’s pensions and investments.
“From 2030 onwards the message is unequivocal: if you are negatively impacted by this, tough. The Government is clear it will not provide any kind of compensation to those who lose out as a result of the downgrade in the value of RPI.
“While the average difference between RPI and CPIH might look small at 0.8 percentage points, over time that could lead to a retirement income worth thousands of pounds less.”
What to expect in today's spending review:
- Rishi Sunak will reveal a multi-billion pound jobs package to try and get Brits back into work who have lost their jobs because of Covid
- He is expected to announce Britain will cut foreign aid this year to pay back some of the Covid debts
- A public sector pay freeze is on the cards for millions of workers to try and save money
- The Chancellor will reveal a gloomy financial outlook for years to come as the virus continues to ravage the economy
- But GDP is set for a strong bounce back next year as the vaccine is rolled out and it's hoped Britain can get back to normal
- Brits may face a pensions cut as he mulls a change to the way they are worked out to try and claw back extra cash
- The Chancellor may announce whether the £1000 Universal Credit uplift will remain in place beyond April
What other changes have been announced in the spending review?
Pay freezes for some public sector workers have been announced as the government looks to plug the black hole in the country's finances caused by the coronavirus crisis.
Mr Sunak was also expected to make a decision on whether to extend the temporary boost to Universal Credit, however he remained silent on the issue in his speech.
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The chancellor also unveiled a three-year programme — the Restart Scheme — to try to assist more than a million long-term unemployed.
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There will be a further £1.4billion of funding for Job Centre Plus.
Mr Sunak will also confirm funding for the next stage of his Plan for Jobs, including £1.6billion for the Kickstart programme, which the Treasury says will create up to 250,000 subsidised roles for youngsters.
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