Private pensions to suffer alongside public sector cuts

14 July 2010

The government is planning to change how private sector pensions are calculated so that all pension members will ‘share the pain’ of reduced payments in retirement.

From next year, final salary pensions will be increased in line with the consumer prices index (CPI) rather than the retail prices index (RPI). It was previously thought that this would only cover public sector and state pensions, but it will now also extend to the private sector.

Such a move will likely make pensions less generous as the CPI – which does not include housing costs unlike RPI – is typically lower than the RPI. Over the past 20 years it has been higher than the RPI only three times.

Dr Stephen Barber, adviser on economics and markets at brokers Selftrade, comments: "Occupational pensions will see a significant drop in valuations as a result of this link to CPI rather than the usually higher RPI.

"In part this move is of course political. Consistent with state and public sector pensions, it shows we are all sharing the pain."

The planned move will mean changes to the amount final salary scheme members receive each year in retirement. It will also affect people’s pensions when they move jobs.

When you leave a final salary scheme you are entitled to a preserved pension. Until now the government has required that these preserved pensions are revalued in line with RPI each year until retirement, but this will change to CPI.

The proposals mean up to 12 million final salary scheme members face a cut in their pension.

TUC general secretary Brendan Barber calls the inflation announcement by pensions minister Steve Webb "a stealth cut on the pensions of middle income Britain".

He says that while the coalition "undoubtedly deserves praise for their early commitment to linking the state pension to the higher of earnings or prices, it now looks as if most other pensions will go up less than they used to in most years".

However, for some companies it will be music to their ears. Firms like British Airways, Royal Mail and BT have enormous deficits in their final salary pension schemes and by changing the inflation measure it will mean the liabilities are reduced.

Barber says savers and investors should review their portfolios to help them better prepare for retirement. He also believes there may be opportunities for investors as some of the big pension companies may see a "welcome boost to returns" following the announcement.

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