Spending Review: RPI inflation will be phased out in February 2030

The Treasury today handed investors and pensioners a reprieve by declining to phase out a flawed way of measuring inflation until 2030, but they still face a more than £100billion hit from the shake-up in the long run.

The retail prices index measure of inflation will be altered in February 2030, saving the Government £2billion a year in interest payments on RPI-linked bonds, the last of which will be issued in a decade’s time.

The Chancellor’s decision not to bring forward the move is a relief for investors, insurers and pension funds who were expecting an even bigger hit if the changes were brought in as soon as 2025, but they still face a £122billion one.

And it means students and commuters will continue to face higher bills for the next decade, as the interest on student loans and the cost of train tickets rise in line with RPI.

Rishi Sunak said in a letter published today that RPI would be phased out from 2030, but not sooner to protect holders of inflation-linked Government bonds

Rishi Sunak said in a letter published today that RPI would be phased out from 2030, but not sooner to protect holders of inflation-linked Government bonds

Rishi Sunak said in a letter published today that RPI would be phased out from 2030, but not sooner to protect holders of inflation-linked Government bonds

What is the proposed change?

The Government has been consulting since the March Budget on whether to bring RPI in line with the CPIH, a consumer prices index that takes into account the cost of housing, as soon as 2025.

RPI has not been classed as an official statistic since 2013 and has a flaw which causes it to be around 0.8 percentage points higher than it should be.

Last month’s CPIH, the Government’s preferred way of calculating price rises, stood at 0.5 per cent, compared to 1.3 per cent for RPI.

RPI is already due to be retired from use in 2030, but it was up to the Chancellor to decide whether to phase it out sooner, with the Treasury seeking views on whether to replace it with CPIH earlier than that, with 2025 the earliest it could have been scrapped.

How have March RPI and CPIH figures differed since 2012? 
Year  RPI figure  CPIH figure  Difference 
2012-13 3.6% 3.1%  0.5% 
2013-14  3.3%  2.5%  0.8% 
2014-15  2.5%  1.5%  1% 
2015-16  0.9%  0.3%  0.6% 
2016-17  1.6%  0.8%  0.8% 
2017-18  3.1%  2.3%  0.8% 
2018-19  3.3%  2.3%  1% 
2019-20  2.4%  1.8%  0.6% 

Who does it affect?

There are four major groups who are affected by the decision to phase out RPI. 

On one hand, commuters and students are disadvantaged because student loan interest rates and train fares are pegged to RPI, which means they rise by more than the ‘real’ cost of living as judged by national statisticians.

Regulated rail fares like season tickets rise each year in line with the RPI figure from the previous July, which this year was 1.6 per cent, higher than the CPIH rate of 1.1 per cent.

Last year, the difference was larger at 0.8 percentage points, and one commuter who caught the train from Kent to London told This is Money he would save around £60 a year on his season ticket if the rise had been calculated using CPIH rather than RPI.

Rises in train tickets are pegged to RPI, meaning commuters frequently see price rises every year higher than official inflation measure

Rises in train tickets are pegged to RPI, meaning commuters frequently see price rises every year higher than official inflation measure

Rises in train tickets are pegged to RPI, meaning commuters frequently see price rises every year higher than official inflation measure

Meanwhile March’s RPI figure is used to calculate the interest rate in student loans, with students and graduates charged the rate of inflation plus up to 3 per cent depending on whether they are still studying or not.

This year the March CPIH was 1.5 per cent and the RPI 2.6 per cent, a difference of 1.1 percentage points. Some mobile phone contracts also rise in line with RPI.

On the other hand, government bonds issued to investors and pension funds which are linked to inflation often rise in line with RPI, not CPI or CPIH, which are much newer measures of inflation.

With CPIH around 0.8 percentage points lower than RPI, switching inflation measures would result in holders of these kinds of investments seeing their bonds rise by less each year. 

A House of Lords Committee last year estimated inflation-linked bondholders benefit by around £1billion a year in extra interest as a result of using RPI.

The Bank of England has issued index-linked government bonds since 1981, before more recent inflation figures came into force. Using RPI has benefited gilt holders by £1bn a year

The Bank of England has issued index-linked government bonds since 1981, before more recent inflation figures came into force. Using RPI has benefited gilt holders by £1bn a year

The Bank of England has issued index-linked government bonds since 1981, before more recent inflation figures came into force. Using RPI has benefited gilt holders by £1bn a year

It was these bondholders Rishi Sunak had in mind when he told the UK statistics watchdog that RPI would not be brought into line with the lower CPIH until 2030.  

And as well as pension funds which often hold billions of these bonds, ‘final salary’ pension schemes which provide savers with a guaranteed income in retirement are often pegged to RPI, meaning how much they rise each year could fall following the change. Annuities are also often linked to it.

As Matthew Davis, a partner at pensions consultants Hymans Robertson, told This is Money at the start of this year: ‘One possible outcome from the RPI consultation is that this type of RPI-linked pension could end up growing more slowly in future, perhaps by about 1 per cent a year.’

Research by the Pensions Policy Institute earlier this year said nearly two-thirds of UK final salary schemes uprated their payouts in line with RPI.

What could the cost to investors and pensioners be?

Investors and pension funds appear to have avoided the worst when it comes to the cost of the changes.

BT’s pension fund, Britain’s biggest private sector scheme, warned earlier this year a switch from RPI to CPIH in 2025 would cost it £1.7billion, while the accompanying research from the PPI found the fall in the value of investments and payouts could cost the average man 8 per cent of their retirement income and the average woman 9 per cent.

The Pensions Policy Institute found 64% of defined benefit pension schemes uprated their benefits every year in line with RPI. This means pensioner incomes could fall from 2030

The Pensions Policy Institute found 64% of defined benefit pension schemes uprated their benefits every year in line with RPI. This means pensioner incomes could fall from 2030

The Pensions Policy Institute found 64% of defined benefit pension schemes uprated their benefits every year in line with RPI. This means pensioner incomes could fall from 2030

Nonetheless, the changes will still be costly. BT said it would still cost £1billion to make the switchover in 2030, and the Association of British Insurers said the overall hit could be as much as £122billion. 

According to the DIY investment platform AJ Bell, someone with a £20,000 a year pension linked to RPI could lose £119,000 in retirement income over 30 years if it was linked to CPIH at 2 per cent rather than RPI at 2.8 per cent.

Alex Waite, a partner at consultants Lane, Clark and Peacock, added: ‘We estimate that a typical 65-year-old woman will see her pension end up 15 per cent lower under the new measure than if RPI had been retained, for a man this would be slightly lower at 14 per cent. 

‘For a pension of £10,000 per year – her pension could end up £1,500 lower.’

Steven Cameron, pensions director at Aegon adds: ‘A technical change to the way the inflation index is calculated, as announced alongside the Spending Review, is an unlikely candidate for grabbing people’s attention. 

‘But if you’re one of the millions who receive an inflation protected pension from a defined benefit scheme or annuity, it could impact negatively on your pension income for the rest of your life.’

He adds: ‘While the Government and its statisticians may correctly argue that CPIH is a more robust measure of actual increases in the cost of living, this is unlikely to appease those in defined benefit pensions who’ll see this as losing out on what they believed they were entitled to. 

‘And this won’t just affect those who are already retired. Anyone in a defined benefit pension considering taking advice on transferring to a defined contribution pension is likely to see the transfer value offered cut to reflect lower future increases had they stayed in the scheme.’

The Government’s plan to replace RPI with CPIH is a clear case of using the wrong tool for the job. CPIH is a totally different measure which produces totally different results – and it may have negative consequences for consumers, workers and savers.
Stian Westlake – Royal Statistical Society 

Any costs for investors and pensioners will have to be swallowed by them alone, with the Government stating in its consultation response that it will ‘not offer compensation to the holders of index-linked gilts’ for the watering down of their investments.

David Gibb, a financial planner at the wealth manager Quilter, said: ‘For those confused about the impact and what it means for their retirement plans its critical to speak to a financial planner or their scheme so they can understand what action they may need to take.’

Stian Westlake, chief executive of the Royal Statistical Society, said: ‘The Government’s plan to replace RPI with CPIH is a clear case of using the wrong tool for the job. 

‘CPIH is a totally different measure which produces totally different results – and it may have negative consequences for consumers, workers and savers.

‘As the CPIH is to replace the RPI, then a full review should be conducted to look into what the possible consequences will be, and how to avoid the likely problems.’

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