How inflation will hit your pension savings

Many pension schemes that offer protection from price rises aren’t as good as they seem, says David Prosser.

Millions of pensioners with supposedly gold-plated private-pension plans are going to take a big hit from inflation. 

XPS Pensions, a pensions consultant, warns that more than four million pensioners in final-salary schemes and other plans offering guaranteed retirement benefits will not see their incomes rise in line with soaring inflation – now running at 10.1% – even though their schemes ostensibly offer inflation-proofing.

The problem is that while final-salary schemes promise inflation-linked annual pension increases to pensioners once they start receiving retirement income, the small print of most schemes imposes a cap on such rises. These caps, known as limited price indexation (LPI), typically restrict annual pension increases to 5%. Many pensioners will be unaware that their schemes feature LPI restrictions. Until inflation began to spike upwards at the end of last year, it had not gone above 5% since the early 1990s, rendering LPI caps irrelevant.

Now, however, LPI means many final-salary scheme pensioners will this year see their incomes go up by just 5% despite inflation running at more than twice that level; it is expected to rise even further in the months ahead. 

Missing out on £25,000 

Not all final-salary schemes impose LPI restrictions, but XPS’s analysis suggests around 4.5 million pensioners are currently in schemes that do feature such clauses, predominantly in the private sector. It suggests that the average 66-year-old pensioner will now miss out on £25,000 of income over their lifetime because of LPI, and also potentially face a squeeze on their household budgets in the short term as their income fails to keep pace with rising prices. Those considering taking early retirement over the next couple of years could be particularly hard hit, XPS warns. In some cases, the trustees of final-salary pension schemes do have discretion to make additional pension awards to pensioners. 

However, many schemes will lack the funding to show such generosity – and, in any case, trustees must balance the interests of different groups of members, avoiding measures that could reduce the benefits available to future pensioners, for example. Still, the news is better for this last group. In most cases, the pension benefits earned by savers yet to retire and begin claiming their income are not affected by LPI clauses. 

Instead, the incomes they have saved for so far do increase in line with the full rate of inflation until they reach retirement. The controversy over LPI is likely to mirror the row about the extent to which state-pension payments should guarantee inflation-proofing. The government’s triple-lock promise – that state pensions will rise by the highest of 2.5%, inflation or average earnings growth – was suspended last year as earnings rose sharply following the Covid-19 pandemic. 

Ministers have since reinstated the promise, meaning that pension payments in 2023 will go up in line with the rate of inflation in September 2023, which is expected to be above 12%. That will impose significant costs on the Treasury, prompting complaints that older people are being given more support than other groups during the cost-of-living crisis.

Recommended

Should I buy an annuity now? Annuity rates reach 14-year high
Pensions

Should I buy an annuity now? Annuity rates reach 14-year high

Retirees can now make their original pension pot back in 15 years, down from 22 years. We look at whether now is a good time to buy an annuity.
5 Oct 2022
The Burberry share price looks like a good bet
Trading

The Burberry share price looks like a good bet

The Burberry share price could be on the verge of a major upswing as the firm’s profits return to growth.
5 Oct 2022
What’s happened to Credit Suisse stock?
Bank stocks

What’s happened to Credit Suisse stock?

Credit Suisse stock has slumped on rumours that the bank is in trouble. Is there any truth in this speculation?
5 Oct 2022
Markets may have bounced, but this is not the end of the bear market
Stockmarkets

Markets may have bounced, but this is not the end of the bear market

Stocks are back on the rise, commodities and precious metals prices are up – even the pound has rebounded. But none of this is typical of bull markets…
5 Oct 2022

Most Popular

Should you take a 25% tax-free pension lump sum in instalments?
Pensions

Should you take a 25% tax-free pension lump sum in instalments?

Taking out a 25% tax-free lump sum sounds appealing but it might not be the best way to manage your pension
30 Sep 2022
Mortgage early repayment charges: are they worth the cost?
Mortgages

Mortgage early repayment charges: are they worth the cost?

With interest rates set to rise further in the months ahead, is it worth swallowing early repayment charges to refinance your mortgage today?
4 Oct 2022
Why the Bank of England intervened in the bond market
Government bonds

Why the Bank of England intervened in the bond market

A sudden crisis for pension funds exposed to rapidly rising bond yields meant the Bank of England had to act. Cris Sholto Heaton looks at the lessons …
30 Sep 2022