Tuesday, 10 August 2010

How to Rob a Pension

One of the measures announced in the recent Budget is the subtle change from uprating pensions and benefits by the Retail Prices Index (RPI) to the Consumer Prices Index (CPI). Both are measures of inflation, but the CPI is the one used by the Bank of England when setting interest rates, in line with EU practice to allow like-for-like comparisons across EU states. The Government have therefore argued that it is more appropriate to use this measure rather than the older RPI.

But crucially, the CPI is often lower than the RPI, making it cheaper to use.

The Government's proposals involve:

  • Linking increases in working age benefits to the CPI in the future, which will effectively mean that benefits will increase at a slower rate over the longer term, limiting the rate at which the benefits bill increases;
  • Replacing RPI as the measure for inflation for State pensions, although with the introduction of the 'triple-lock', meaning that State pensions will increase by the higher CPI, National Average Earnings Index (NAEI) or 2.5% (subject to a maximum of 5%) means that the effect on State pensions will be minimal;
  • Most importantly, final salary pension schemes - including schemes in the private sector - uprate benefits in line with RPI each year subject to a 5% cap as a statutory minimum. This would be changed to CPI, affecting not just members of pension schemes, but pensioners in receipt of income as well.

This is the key one. The last point won't just affect pensions in the public sector, but those in the private sector as well. It effectively means that final salary pension schemes will only need to uprate deferred benefits - belonging to non-contributing members of the scheme -  by the lower of CPI or 5% each year, and that existing pensioners - people already receiving their pension - would have that income increased at a lower rate in the future.

Previously, changes to the method of pension uprating have preserved the uprating for previously accrued benefits. The Government is proposing a retrospective change, so that all deferred benefits will accrue at the same rate, i.e. the lower of CPI or 5%.

This will have several effects:
  • It will make the Government's bill for supporting the various public sector pension schemes, such as the Teachers Pension Scheme, the Local Government Pension Scheme, the Civil Service Pension Scheme and dozens of others, considerably cheaper going forward;
  • It will make far more private sector schemes more sustainable, as their long term commitments will be more manageable - their future liabilities will be lower, and therefore the scheme's assets will be under less pressure to produce higher investment performance;
  • Ultimately, the people who will suffer will be the pension scheme members - their entitlement will be accruing at a lower rate, and therefore their income in retirement will be lower. But uniquely, it would also be existing pensioners who would suffer - their actual income would increase at a lower rate.
Of course, private sector funds may still choose to make provision beyond the statutory minimum, but it is unlikely. I work in the financial services industry, and have only come across one pension scheme which makes provision above and beyond the statutory minimum.

Hand it over, Grandma

This is a tiny change, but one that will have massive repercussions if borne out in full. It will not just affect people's future pension entitlement, but their existing entitlement as well, including those who have already retired. The principal of changing the uprating method for future accruals is a relatively sound one, but the application of retrospective legislation to existing provision is, quite frankly, despicable.

It has echoes of Gordon Brown's decision to remove the tax credit for share dividends on pension funds, effectively allowing pension funds to fall into the Corporation Tax net. A small change that very few people really understood, but which had huge consequences for millions of ordinary people.

From the coalition, I expected better.

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