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Inflation switch hits pension rises

Inflation switch hits pension rises

Category: Pensions

Updated: 12/10/2010
First Published: 12/10/2010

This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

Pension increases next year will be almost a third lower than they would have been if the Government had not decided to switch its benchmark
from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI).

Following the confirmation of September's inflation figures by the Office for National Statistics, Towers Watson said payments from public sector pensions, the State Second Pension and some private sector defined benefit pensions will rise by 3.1% instead of 4.6% next year.

In June's emergency Budget, the Chancellor announced that the pensions of retired public servants would rise in line with inflation as measured by CPI rather than RPI from April 2011, a change which also applies to payments from the State Earnings Related Pension Scheme and the State Second Pension, as well as some social security benefits.

As a result, someone receiving £10,000 this year from a public sector pension scheme can expect their payments to rise by £310 in April, instead of the increase of £460 which would have been forthcoming under the old rules.

With CPI inflation usually lower than RPI inflation, John Ball, head of UK Pensions at Towers Watson, said it was likely the gap between the pension they would have received and the pension they will now receive will get wider over time.

"If the forecasts used in the Budget prove correct, their annual income should be about £900 lower than it would have been by 2016," he added.

"As Lord Hutton argued, the taxpayer has been promising more expensive pensions to its employees than it should have been. The rules governing these schemes allow the Government to measure inflation however it wants to, and changing to CPI is a way of sharing the pain with people who worked in the public services in the past."

The consultants have also estimated by how much the Basic State Pension will rise next year.

The Government's 'triple lock' means that the rise in the Basic State Pension next April will be which ever is highest out of average earnings growth, RPI inflation and 2.5%.

CPI inflation then takes the place of RPI inflation in the formula from 2012.

With earnings growth having recently been below inflation, Towers Watson said it therefore appears likely that the April 2011 increase will reflect September RPI inflation.

As a result, in April next year the Basic State Pension is expected to increase from £97.65 to £102.15 for single pensioners and from £156.15 to £163.35 for couples.

"The irony is that the earnings link has been restored during a rare period when prices are growing faster than earnings," said John Ball.

"In 2012, pensioners are forecast to get a smaller increase than they would do with the old RPI link. Over time, however, the earnings link is an expensive commitment and the State Pension Age will have to rise faster to help balance the books."

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