Published On: Thu, Aug 20th, 2020

Pension values may drop by £80billion if state proposals are introduced – reforms implored | Personal Finance | Finance

Pension schemes can be set up through two different types of plans: Defined Contribution (DC) or Defined Benefit (DB). DB schemes are generally much more generous and the income from them can be affected by how inflation moves.

However, measuring inflation in itself can be controversial as two differing measures can be used.

Inflation can be either measured through the Consumer Price Index (CPI) or the Retail Price Index (RPI) but this creates an imperfect setup as one is usually higher than the other, which has a knock on effect on pensions, mortgages and other financial arrangements.

To try and rectify these issues, the government has expressed that it may align RPI with CPIH, which is more robust than regular CPI.

While nothing has been confirmed yet, PLSA warned that if these changes are made, certain pension schemes will suffer.

READ MORE: Pension: A CPI & RPI consultation will end this week – be aware

The PLSA went on to provide analysis on how individual schemes may be impacted: “Depending on their age and the timing of the change, individual pension scheme members will lose an average of between four and nine percent of their total lifetime pension income.

“A man aged 65 in 2020 could see a drop in his yearly average DB income by as much as 17 percent if changes are made in 2025 and a woman of the same age could see her yearly average DB income drop by 19 percent, also if changes are made in 2025.

“This is because the level of annual inflation protection will be lower in future under a CPIH-based methodology compared to the current RPI-based approach.”

They concluded by providing potential solutions to this conundrum.

The PLSA proposed that there should be a transition away from the use of RPI entirely in a fair and equitable way.

They detailed that the government and the UKSA could adjust index-linked gilts (a gilt being a bond issued by the government) from RPI to CPIH plus a transparently calculated adjustment reflecting the expected long term average future income of RPI over the new inflation measure.

This solution, according to the PLSA, is already recognised in the pension industry as “CPIH + a spread”.

Alternatively, the PLSA sad that the government could also consider paying any future lost income to index-linked gilt holders upfront.

Tiffany Tsang, a Senior Policy Lead for the PLSA, commented on these proposals: “The decision to develop a more robust measure for inflation is the right one but the proposed methodology risks billions of pounds in pension assets.

“Pension schemes have made RPI-linked investments in good faith, and under the guidance of the regulators, to prudently fund pension benefits. They should not face short-falls as a result of the changes.

“Moreover, the new method of calculating how much to increase pensions each year to take account of inflation could result in cuts to people’s pensions of up to nine percent over a lifetime. This will make it less likely they will have an adequate income in retirement.

“In its plans to reform the inflation measure, we strongly urge the Government to mitigate the detrimental impact this change will have on holders of index-linked gilts and find an equitable transition away from RPI.”

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