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10 January 2013 last updated
Annuities escalation stays unchanged is relief for pensioners

The calculation for the Retail Price Index (RPI) has not been changed by the Office National Statistics (ONS) which would have seen income from annuities escalation linked to RPI decrease for pensioners.

The main concern has been investors and savers of index-linked gilts and bonds worth £280 billion and the estimated loss of income of £2.8 billion a year if the adjustments were introduced.

A change in the RPI would have affected pensioners eliminating the gap between the Consumer Price Index (CPI) and RPI which is currently 1.2% due to the formula in calculating the average price of goods and services.

Annuities can have RPI escalation added to to protect the income against inflation and the amount offered initially for a given pension fund is based on the expectation of RPI. If this was to lower the percentage it would mean all existing annuities would offer worse value in the future as the increases would be less.

 
Annuities escalation unchanged
 
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How the retail price index is changing

The Office for National Statistics has avoided the impact on pensioners savings and RPI annuities escalation and created a new index called RPIJ.
This new index corrects the error in the calculation of RPI against CPI where the latter is used by the Bank of England's Monetary Policy Committee (MPC) for the inflation target currently 2%.

CPI is based on international standards specified in European regulations and includes hundreds of prices of goods and services purchased by consumers whereas RPI also includes housing costs and mortgage interest payments which can create significant differences to CPI over time.

The ONS has based RPIJ on average prices and is expected to operate in parallel to RPI from March 2013 although the latter will still be used as the measure for index-linked gilts and bonds as well as annuities. Had this adjustment been made to RPI it would have resulted in the government saving £3 billion a year in interest payments at the expense of savers in National Savings & Investments index-linked certificates and pension funds.

The annuity income cost if RPIJ was used

This index would significantly reduce the income to pensioners that have already purchased their annuity as annuities cannot be changed once set-up. As an example if a single male aged 65 with a fund of £100,000 could purchase an RPI escalating annuity with an income of £3,500 pa. If RPIJ was expected to be 1.0% less than RPI over the lifetime of the pensioner the income paid would be £8,175 lower.

On the other hand for those that are buying a new RPI annuity the provider could increase the annuity rates income paid to £3,850 pa and the annuitant will be better off by £350 pa. This would occur as the provider will not have to pay such high rates of escalation in the future and could afford to offer more competitive rates and maintain their expected profitability.

Related internet links:
BBC - No change to RPI calculation
Telegraph - Relief for pensions as ONS leaves RPI unchanged
Guardian - RPI review recommends new inflation index
Telegraph - RPI, CPI and RPIj explained
Telegraph - Pensioner backlash expected over inflation reform
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