Government plans to change the way the retail price index is calculated could see savers' lifetime pension income drop by almost 20 per cent as defined benefit schemes are hit.
Research by the Pension Policy Institute (PPI), published today (April 1), has shown a saver aged 65 in 2020 could receive up to 21 per cent less per year from his DB pension by the age of 90 depending on when the RPI calculation methodology is changed.
The government is looking to align RPI with the consumer prices index including housing costs. RPI generally runs at about 1 percentage point higher than CPI and is currently 2.5 per cent, compared to a CPI of 1.7 per cent.
This could cause both pension funds and annuities to fall in value as index-linked gilts link their payments to RPI.
According to the PPI's calculations, a 65 year old male is expected to live until 86 under current life expectancy projections.
His yearly average DB income under RPI uprating would be around £6,300 each year.
But this could drop by 17 per cent to £5,200 per year if the change took place from 2025, or by 12 per cent to £5,500 per year, if it took place in 2030.
Women are even worse affected by these changes as they have a longer life expectancy and could expect to see their retirement income reduced by almost 20 per cent if the change were to take place from 2025.
The government has currently proposed to make the change between 2025 and 2030.
According to the PPI a 65 year old women with a life expectancy of 88 could see pension incomes drop to £5,000 per year from £6,200, a 19 per cent decrease, if the change took place from 2025.
If the change were to take place in 2030 her income would be reduced by 15 per cent to £5,300 per year.
Daniela Silcock, head of policy research at the PPI, said: "As CPIH inflates more slowly than RPI, schemes invested in gilts will experience a drop in overall scheme assets of around £17m per £100m invested, if the reform is introduced in 2025 and around £13m per £100m if the reform is introduced in 2030.
"Private sector DB schemes collectively have around £470bn invested in index-linked gilts and could experience an overall reduction in asset value of between £60bn and £80bn depending on when the reform is introduced."
She added: "Women and younger pensioners will experience the greatest reduction as women live longer than men, on average, and younger pensioners will experience a compounding effect.
"Older pensioners on low incomes will also struggle with a reduction in benefits as they have less opportunity to make up income deficits than younger members.”
If the calculation methodology changes, the government will get to make lower interest payments to RPI linked gilts.
In turn, pension schemes or insurance companies that have sold RPI linked annuities, which are backed by these gilts, will make lower increases to the incomes received by their members.
The payments will still be in line with RPI, but they will just rise slower than they currently do using today’s calculation methods.
Tom McPhail, head of policy at Hargreaves Lansdown, said: "Anyone who has joined a pension scheme or bought an annuity expecting to receive RPI linked increases to their income, should continue to receive those benefits in line with the contract they bought into.
“Arguing that they’ll still receive an RPI-linked benefit but then changing the definition of what RPI means, is a bit of Alice in Wonderland logic; it looks like it could be an April Fool but for anyone facing the prospect of losing up to 21 per cent of the value of their pension, this is no laughing matter.”
To avoid this Mr McPhail suggested the government could continue to calculate and publish a legacy RPI for existing contracts, so that anyone receiving contractual benefits today could continue to enjoy the current calculation methodology.
They could then use the new calculation method for all contractual obligations entered into after a specified change date, he said.
amy.austin@ft.com
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