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.