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How will inflation affect your pension?
Just 16% of adults understand how the government's 'inflation switch' is affecting their retirement savings.
by Michelle McGagh on Aug 16, 2012 at 09:50
Pension savers are still in the dark about the impact the ‘inflation switch’ brought in by the government two years ago will have, despite the possibility that it could wipe 25% off their retirement income.
Research by human resources business Aon Hewitt shows Brits do not understand what effect the switch from the retail price index (RPI) to the consumer price index (CPI) has had.
Switch from RPI to CPI
Two years ago, the government announced plans to move the indexation of pensions from RPI to CPI. It did this because CPI rises a lot slower than RPI, as the latter includes housing costs, so it means the state pension will rise more slowly, as will public sector pensions, costing the government less money.
When it comes to private pensions, the amount they pay out could also increase more slowly as many are tied to inflation, and would have adopted CPI instead of RPI.
However, a survey of 2,000 people over the age of 18 showed that just 16% of people felt adequately informed about the relationship between inflation and their pension. Although this is an increase from 10% in 2010, it is still a small percentage of the population. Just 26% of respondents knew the difference between CPI and RPI, a 1% decrease from 2010.
Many were confused about the impact the inflation switch would have on their pension, only 31% correctly said the move would reduce their income in retirement.
1% annual fall = 25% less pension
A total of 3% said their income would be reduced by up to 1% a year, which is what Aon Hewitt expects to happen. It warned that the 1% fall could accumulate and wipe up to a quarter off of savers’ retirement income.
Lynda Whitney, partner at Aon Hewitt, said: ‘Two years after the chancellor announced the switch from PRI to CPI as the inflation measure for public sector pensions and the statutory revaluations for private sector schemes, the public remains in the dark over the difference between the two, and whether their pension is impacted.
‘Furthermore, the majority of people are unaware of the potentially significant effect that changes in inflation and the move to CPI could have on their income in retirement. 1% a year may not sound much but over both the period from leaving service to retirement and the retirement period this could lead to a reduction of 25% of their retirement benefit.’
Do you understand inflation?
As part of its survey Aon Hewitt asked people to calculate the following sum to see if they understood inflation:
‘Calculate the decreased buying power of £100 after 10 years of CPI at 2%, the Bank of England’s target rate’. The answer: £20.
Whitney said: ‘Most people might need a calculator to reach the precise answer, but I would hope they could think that if 2% of £100 is £2, then £2 a year for 10 years is £20.’
However, just 34% of people were in the correct range for the answer of £10 to £25.
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