Price inflation in retirement
Price inflation and pension benefits have been in the news recently following a consultation to change the rules for the British Steel Pension Scheme.
According to one expert, the small print in this government consultation reveals that the oldest and most vulnerable pensioners in society could lose the most from such a rule change.
The consultation small print would allow trustees of the British Steel Pension Scheme to reduce inflation protection from the Retail Prices Index (RPI) to the Consumer Prices Index (CPI).
Moving from RPI to CPI matters because CPI is typically lower than RPI.
Steve Webb, former Pensions Minister and now Director of Policy at Royal London, says that such a move could result in an 80 year-old pensioner on a pension of £100 per week losing over £10,000 during the next ten years when compared with the current rules.
Because it is a fairly technical change, there is a risk that members of the British Steel Pension Scheme will be unaware of the consequences of the consultation.
Another rule change open to consultation would result in some pensioners having their pension (and any pension for their widow) completely frozen or largely frozen.
This is because the legal requirement to index all of a pension in payment only applies in respect of years of service since 1997.
For pensionable service before that date, there is only a very restricted legal requirement to uprate the pension and only then for a limited period.
This means that an older pensioner who did all of their service before 1997, and particularly before 1988, could have their pension frozen.
More generally, older pensioners who did most of their work before 1997 will see a large part of their pension frozen with only a very small annual increase.
Webb explain this possibility is specifically mentioned in paragraph 85 of the consultation document which says that “If adopted, this [rule change] would mean that in the future existing pensioners would receive lower increases to their pensions than they would under the current scheme rules, or possibly no increases at all,”
The independent Office for Budget Responsibility has estimated that in the long-run the RPI will generally be about 1.4% above the CPI.
Assuming that CPI reverts to its Bank of England target of 2%, this suggests a long-run RPI level of 3.4%.
An 80 year-old pensioner on £100 per week who did all of their service before 1997 could see their pension frozen at £100 for the rest of their retirement, rather than see it rise to £103.40 after one year, £106.92 in year two and so on.
Adding up all of these differences over a ten year period means that this pensioner would lose over £10,000 in total, excluding the ongoing freeze of any pension payable to a surviving spouse.
Widows, who make up around one third of the ‘pensioner’ members of the British Steel Pension Scheme, could be particularly affected.
Commenting on the implications of the consultation, Steve Webb said:
“The rules around pension uprating are complex, and the Government’s consultation document is far from clear about how this change will disproportionately affect older and more vulnerable pensioners.
“This is not simply a case of switching from one inflation measure to another.
“Many thousands of older steel workers and their widows could see their pensions largely frozen for the rest of their life if these plans go ahead, with losses running into thousands of pounds.
“This is a big issue for the steel workers scheme, but an even bigger issue if the principle is applied to a wider group of salary-related pension schemes.
“This potentially huge impact, buried in the small print of the government’s consultation document, highlights the way in which rushed legislation can all too often have unintended consequences.
“The Government and the pension scheme need to make sure that older workers know what is happening and feed in to the consultation process.”
Everyone entering retirement needs to consider the impact of price inflation on the buying power of their pension income.
Even modest price inflation can have a significant impact on a level pension income over the long-term.
With retirements now often lasting for 20, 30 or more years, inflation is one of the biggest challenges we all face as we design the most suitable retirement income strategy for later life.