Planning for retirement – be aware that inflation matters

Imagine if your pension was cut by 15% in five years? Although the September inflation numbers, which set the basis for many indexation increases next April, are the lowest since November 2009, the purchasing power of your savings will be significantly reduced over a number of years.

Inflation: Down But Not Out
In September 2011, inflation peaked a 5.2% on the government’s preferred Consumer Prices Index (CPI) measure and 5.6% on the more familiar Retail Prices Index (RPI). As a result most benefits, including state pensions, rose by 5.2% from April 2012, adding to the Chancellor’s woes.

This time around, Mr Osborne seems to be in luck. The CPI figure for September 2012 was 2.2% (2.6% for the RPI). As a result most benefits will rise by 2.2% (unless the Chancellor decides otherwise). The one important exception is the basic state pension, which is subject to the coalition government’s ‘triple lock’, i.e. the increase is the greatest of:

  • Price inflation (measured now by the CPI)
  • Average earnings growth; and
  • 2.5%.

The latest statistics for earnings (to August) show these are rising by 1.7% a year, so it is a fair bet that the basic state pension will be 2.5% higher from April 2013. That will make it £110.15 for a single person. Other state pensions, e.g. SERPS, should rise by 2.2%.

The inflation numbers hit a low in September because of a statistical quirk. With each set of annual inflation numbers, the oldest months increase drops out while the new month’s changes come in. If there are yearly price increases this would mean that, for example, the August-September 2011 increase disappears, to be replaced by the August-September 2012 increase. However, while the gas and electricity companies put through price rises of 13% and 7.5% between August and September 2011, there was virtually no change in 2012. This alone cut the annual inflation rate by almost 0.5%.

Utility price rises of up to about 10% are now being implemented and they will push up the inflation rate in the coming months. So too will the increase to £9,000 in the tuition fee ceiling in England, the effect of which is being staged in over three years by the Office for National Statistics (ONS). By the time next April arrives, pension increases based on September 2012 inflation could look distinctly parsimonious.

RPI changes ahead?
One important issue is the gap between the RPI and CPI, which is currently 0.4% but has averaged 0.65% a year over the last ten years. Some of this is down to different components – the CPI does not include mortgage interest for example, hence the big difference in 2008/09, when interest rates plummeted. However, with mortgage rates relatively flat, currently the main reason is the different mathematical bases for the two indices. In October ONS published a consultative paper suggesting several ways of dealing with the RPI-CPI gap. If any of these are adopted, inflation, as measured by the revised RPI, will be lower than under the current RPI. That would suit the government, which has £280bn of RPI-linked borrowing in the form of index-linked gilts.

Inflation still matters, even if this September’s figure is low. Over the last five years, the buying power of £1 has dropped to about 85p, whether you use the CPI or RPI as your yardstick. Unless your financial plans take account of inflation, they can easily drift into inadequacy.

If you have any questions regarding retirement planning or financial planning please contact us on 020 3865 2379


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