Thursday, 8 December 2011

Inflation Ignored in Public Sector Pension Reforms Furore

I wanted to mention the effect of inflation. It's well covered on the web, but still so many people are ignorant of this transfer of wealth away from savers that I thought yet one more post on the subject wouldn't hurt.

This ignorance has been evident in the recent uproar over public sector pension reform. Perhaps I should have said ignored rather than evident. One of the changes implemented has been that the inflation linking has been moved from RPI to CPI, capped at 2.5%. This has been applied across all pensions, both public and private sector.

Both the cap and change of index are unfair to pension savers and something that both private and public sectors can unite over. With RPI at 5.4% and CPI at 5.0%, the cap is in effect. Your UK pension is not really inflation linked. It is guaranteed that your pension savings are losing value.

The graph below shows what happens to the spending power of £10,000 in the case that these rates were to stay the same over 30 years.

Your £10,000 will lose 57% of its value.

The change of index does not in itself guarantee that your pension will further lose value, but over the last decade or so CPI has been consistently lower than RPI*. Both indices are significantly lower the the rise in costs of the basics - energy and food. It is likely that your pension will buy you a lot less of what you need by the time you come to retire. Be prepared!

Now you may think that the inflation target is 2% and we'll get back on track soon. That's certainly what Mervyn King has been telling us for years. However, I have little faith in this. Here's the historical RPI since 1960. With the new rules, whenever that blue line is above the red your "index linked" pension would lose spending power. It wouldn't gain spending power when the blue line is below the red (unless we get deflation).

*The main difference between the indices is housing costs, so it may well be that these indices do move closer over the coming years. However, it does appear that government policy is to protect the value of  property. Should we experience a property crash like the US, Ireland, Spain and other countries have seen, the balance sheets of our banks would look very dodgy.

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