Pensioners are about to be robbed yet again

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The Chancellor is poised to alter the way inflation is calculated and interest paid, says Philip Johnston .

The post-Christmas sales are in full swing and prices are tumbling, but who among us can answer this question with any certainty: what is the current rate of inflation? The official figure for November (Xetra: A0Z24E - news) , published by the Office for National Statistics, stood at 2.7 per cent, unchanged on the previous month; yet does anyone recognise that from the real world?

We are talking here about the Consumer Price Index (CPI (Other OTC: CPIC - news) ), adopted as the Government’s official inflation target by Gordon Brown in his pre-Budget statement of 2003, in one of those notoriously garbled announcements that few noticed at the time, but whose impact became apparent in subsequent days.

The CPI superseded the Retail Price Index (RPI). The RPI at least had the virtue of familiarity, having been with us through thick and thin since the late 1940s, and it is still used in some instances, of which more later. Both measure how fast the prices of goods and services increase and rely on a regularly revised basket of items that we are most likely to purchase.

Crucially, however, the CPI excludes housing costs, council tax and home insurance, which make up about 20 per cent of the average household’s spending. And why this omission? Because the methodology was devised by EU statisticians about 20 years ago and since home ownership varies so much across Europe, they couldn’t agree a formula to cover them all.

In other words, far from being a technical change intended more accurately to reflect the lives we lead and the goods we buy, the CPI rapidly came to bear little resemblance to the experience most people have of inflation. In any case, this varies depending on where you live, who you are and what you buy: the cost of living is different for the elderly, for country dwellers (high fuel bills) and for the better-off (rising school fees).

But the CPI had a magical quality that made it irresistible for governments: invariably it was lower than the RPI. So if index-linked benefits, grants and other payments could be based on the new measure, lots of money could be saved.

For a few years at least, the RPI remained the preferred inflation measure for the indexation of pensions, but that ended for many in 2011 when the Government said these could be based on the CPI as well. Private schemes which specified RPI in their rules retained this measure, while schemes whose rules referred only to the statutory requirements moved to CPI automatically, as did all public sector pensions. This decision was taken principally to reduce the liabilities on pension schemes, which are under massive pressure because people are living much longer than actuaries had assumed just a few years ago. Needless to say, it was bad news for pensioners.

According to the Office for Budget Responsibility, the CPI over the coming decades will be about 1.4 percentage points lower than the RPI. This might not sound a great deal; but the incremental effect will amount to a difference of many thousands of pounds in the pension someone will receive during their retirement. In total, the Department for Work and Pensions estimates that inflation switching could cost private pensioners more than £73 billion.

Still, there was one saving grace: government bonds remained linked to the RPI, and since pension funds invested heavily in those, savers were at least getting some benefit of the higher inflation measure.

You can just guess what’s coming next, can’t you? Next (Other OTC: NXGPF - news) month, a report from the Office for National Statistics (ONS) is to be published on the future of the RPI. The ONS has carried out a brief and not very well publicised consultation on a number of options, including whether and how to bring it more into line with the CPI. Doing so would save George Osborne £3 billion a year in interest and hammer yet another nail into the coffin of private pensions, especially those still linked to the RPI. It would also cut the returns on the £18 billion worth of inflation-linked policies which have been sold by National Savings and Investments.

This really makes sense, doesn’t it? We are living longer; we are massively in debt as a nation; we cannot afford to care for our elderly: what better time than now to mess up our pensions even more? After decades of debt-fuelled consumer bingeing, we need to encourage young people to save; and to that end the Government has introduced a system of automatic pension enrolment. But you can opt out and if you can’t trust the government to stick to the deal that you started with, why would you want to join up?

Millions of investors have taken decisions about their futures based on the continuation of the RPI. Pensions, by their very nature, are all about long-term planning; so the integrity of government indexation is crucial. If the goal posts can simply be moved around the pitch at the whim of a chancellor, it is hardly surprising that confidence in a system which just 15 years ago was lauded as the envy of the world is now shot to pieces.

The savers of Britain are justifiably fed up with the larcenous manipulation of the value of their nest eggs. It is rumoured that next month’s report will recommend revaluing RPI downwards by anything up to one per cent. But the final decision will rest with George Osborne, and he must make sure it doesn’t happen. Enough is enough.

* Read more on rising pension ages and how retirement income has been hit