The Wire: Winter 2020 – Savers and retirees to be hit by RPI to CPI switch

(Estimated read time 5 minutes)

Savers and retirees to be hit by RPI to CPI switch

Changes to the way the government calculate the Retail Price Index (RPI) will have a big impact on savers and pension fund holders. In this article, read about what the changes are, and how they could adversely impact up to ten million people.


In the 2019 Budget speech, the then Chancellor Sajid Javid, made an announcement that will have an impact on many savers and pension fund holders.

He confirmed that the independent UK Statistics Authority were intending to reform the way they calculate the standard measurement of index linking, the Retail Price Index (RPI). Javid confirmed the government intended to support aligning it with the CPIH (Consumer Price Index including Housing) rather than treating the two separately. CPIH has historically been around 1% less than the rate of RPI. 

CPI was introduced due to generally accepted errors in the RPI index which actually overstates inflation and it has long been the intention to do away with RPI in favour of CPI, though this is not as simple as it sounds due to far reaching effects. Actually it is the UK Statistics Authority that decide how these indices are calculated, not the Chancellor, but due to specific gilt issues they require the Chancellor’s permission to implement this before Feb 2030, which the Chancellor indicated he would consider, with a 2025 completion date. 

In his financial statement to the House of Commons on 25 November 2020, current Chancellor Rishi Sunak suggested that the changes will be fully implemented by 2030. Since RPI is so ingrained into legislation and such things as DB pension, they will simply align the calculation of RPI with that of CPI rather than trying to get rid of it completely. 

How this change may impact you

In a nutshell, the changes will mean that up to ten million individuals who currently hold savings and pension assets dependent on an annual RPI escalation could see quite a marked drop in the rate of increase.

For example, the average RPI rate over a ten-year period from 2010 to 2019 was 2.55%. The equivalent figure for CPIH was 1.65%. If you project those two different rates over a ten-year period, you can see how different annual incomes could be impacted by a lower escalation rate each year.

Table – Different annual incomes, escalating over ten years at RPI and CPIH

Reduced escalation rates will have a big impact on the value of index-linked gilts, which are used by many critical financial products to provide payouts to beneficiaries. 

The Bank of England has estimated that more than £1 trillion of liabilities are tied to RPI, £800 billion of which are held in individual and corporate pension funds.

It’s expected that the biggest impact will be felt by many UK pension funds, especially those in default / managed funds since they are big holders of index-linked gilts and bonds; if your pension fund holds these assets the growth on those assets is likely to be lower than previously.

You will probably be impacted if you’re a member of a Defined Benefit pension scheme (sometimes called Final Salary scheme) as rules often mandate that members’ retirement incomes rise in line with RPI. They also frequently increase preserved pension after you leave by RPI up to retirement. Likewise holders of index-linked annuities would see their income rise as slower than before. 

It has been estimated that the reduction in pension fund benefits could result in a transfer of wealth from pension fund holders to the UK government of between £100 billion and £130 billion – a rather dramatic stealth tax, to say the least.

Of course there are lots of things with costs that also rise by RPI that will now increase at a slower rate (eg rail fares)  and that will actually benefit many. But no comfort to someone whose core income all comes from an RPI linked Final Salary pension. 

Consultation and responses

When he originally announced the change, Sajid Javid confirmed that there would be a consultation period up to April 2020. Rishi Sunak subsequently extended this to August 2020 because of the coronavirus pandemic.

It’s worth noting that the consultation asked for submissions based on ‘when and how’ the change should be made rather than ‘if’ it should. So, it has always been a case that the change is coming, and it was only the timescale that was up for debate.

In their response to the proposals, the Association of British Insurers (ABI) pointed out that switching to the proposed new measure of inflation within a five year time frame would reduce the value of index-linked gilts by 17%, which is equivalent to £122 billion.

To help reduce the impact, they asked the government to push back the implementation date beyond 2025 to 2030, which is what the Chancellor has now confirmed he will do. However, even this extended transition means the stock of index-linked gilts will still lose around 13% of their value – around £96 billion.

Two other suggestions were made in the consultation process to mitigate the impact:

  • It was suggested that the government establish an independent body to set the level of the new inflation measure.
  • It was also proposed that they continue to use a ‘notional RPI rate’ for pension scheme members which will effectively mean a margin is added to the CPIH rate to reflect the expected long-term average premium of RPI.

The Chancellor referenced neither of these suggestions in his statement. In fact they have confirmed that they will not offer compensation to the holders of index-linked gilts for the watering down of their investments. 

What happens next?

Despite the confirmed ten-year transition to full implementation of the changes, the switch from RPI to CPIH will seriously impact pension fund holders and savers.

Leading actuarial consultants, Lane, Clark and Peacock have estimated that a typical woman retiring at age 65 could see her pension ending up 15% lower with the new calculation method than if RPI had been retained. The equivalent loss for a man would be slightly lower at 14%.

If you are worried that the changes that we’ve outlined here may adversely impact you, please get in touch. We have a wealth of experience and can help guide you through the best steps to protect the future value of your holdings.

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