Pensions outlook bleak

State Pensions look fine on the surface. In April the basic state pension rises from £90.70 a week to £95.25, a five percent increase. The minimum annual increase is 2.5 percent. However pensioner inflation runs much higher than average inflation; while the January RPI figure was almost zero, estimates put pensioner inflation in the same month at above five percent.

Prudent investors who have taken out inflation-linked annuities could find their income falling if inflation turns negative. Annuities from Prudential and Standard Life could fall, while those from Norwich Union and L&G will not decrease but then will not rise until RPI has reached its previous level. AXA policies are under review. Final salary schemes: most schemes will not reduce the income to pensioners in the event of deflation. Then again the income will not rise, meaning that they face a rising cost of living without a concomitant rise in their income.

Laith Khalaf, a pensions analyst commented: “Pensioners suffer higher inflation than the general population yet in many cases their income will remain static because it is linked to the headline RPI figure. Despite today’s low inflation those who are about to retire need to give serious thought to how to hedge against inflation seeing as they could be drawing their pension for upwards of 40 years.” In terms of personal pensions, with the spectre of high inflation looming on the horizon, retiring investors should inflation-proof some of their pension income; where possible splitting their pension three ways between a level annuity, a three percent escalating annuity and an RPI linked annuity is one solution.

Drawdown is an alternative for those with larger pots. Whatever they do it is imperative they do not ignore the inflation risk. State pensions are to be linked to earnings by 2015. This is a positive move but could come earlier. There have occasionally been times when inflation has outpaced average earnings in the past and there could be again in the future. The government might avoid an own goal here by linking the state pension to the higher of average earnings or inflation.

The reported drop of inflation will cause an immediate effect for workers, as
Dr. John Philpott, Chief Economist at the Chartered Institute of Personnel explained: “What a difference a year makes. Last spring’s exaggerated warnings of an impending inflationary ‘pay-price spiral’ seem a million miles away from today’s official figures showing that the UK economy is experiencing zero inflation on the RPI measure, which at least eight in ten employers use as the cost of living benchmark when deciding on staff pay awards.” He added; “For millions of workers this will be a ‘spring and summer of pay depression’ as pay rises give way to widespread pay freezes or pay cuts. This is an exceptional experience. When the UK last entered an annual pay round with zero RPI inflation, Elvis was still in his pomp, Cliff Richard was still hip and the Beatles were still unknown. And at that time the trade unions were still strong enough to prevent pay from falling along with prices. But in today’s flexible labour market pay is better able to adjust downward when inflation falls.”

 “With highly expansionary monetary and fiscal policy and a weak pound set in due course to generate a return to tolerable inflation, there is little prospect of a damaging deflationary ‘price-pay’ spiral emerging in the UK economy. As such, a modest bout of pay depression against a backdrop of zero RPI inflation is good for jobs since it prevents a rise in real pay costs facing firms without hitting people’s real standard of living.  
Dr Philpott concluded; “For the vast majority of workers, accustomed as most of us are to an annual boost to our pay packets, a pay freeze or pay cut will feel like a hardship, especially while the CPI measure of inflation continues to rise which shows that not all the prices people face are in retreat. And with job insecurity on the increase too, the combined effect of zero RPI inflation, rising CPI inflation, and recession is soon going to make it seem as though we are living through a depression.”

With interest rates low and pay likely to be down or frozen, it will be hard to encourage employees who haven’t already started to save for a pension, especially when there is so much uncertainty about which plans will deliver the best deal – or any benefit at all. HR needs to brush up on the information they can provide employees with or bring in experts to give confidential advice to employees. This can be done at a very low cost or for free, but is likely to be appreciated in this period of uncertainty.

Jason Spiller is Editor of theHRDIRECTOR magazine