Switch of inflation index could slash pensions by 20 per cent
A government-initiated change in the inflation link for pensions will wreak havoc on Britons’ pension funds, and savers need to urgently consider their options to mitigate the adverse effects.
It is now just a matter of weeks before there could be a switch in the index to which pensions are pegged, from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI).
This could wreak havoc on pension funds and I’m baffled that very few people seem to be aware of it, let alone causing a fuss about it. It appears to be slipping through almost unnoticed.
Changing the index from RPI to CPI will have a significant, negative effect as CPI is generally lower than RPI – usually 0.5 per cent and 1 per cent. This means that each year individuals with a final salary scheme will receive, say, 1 per cent less increase in their pension payments.
That might not sound much, but when it’s compounded over years it makes a big difference. For instance, if a man retires at 65 and lives until he’s 85, the change from RPI to CPI could lead to a reduction in retirement income by a fifth.
This is extremely concerning as a person in that situation would find that their financial planning is inaccurate by an alarming 20 per cent.
It is imperative for pension savers to start to think about how they could mitigate the negative impact of the index switch over.
In terms of mitigating the risks of the new index, pension holders could consider transferring their scheme into a defined contribution scheme, such as a SIPPS in the UK, or a QROPS (Qualifying Recognised Overseas Pension Scheme) if they live outside of the UK. These schemes are personal arrangements that allow the individual to benefit from greater investment performance and flexibility. Although like all investments, these too can go down as well as up.