Budgeting - CPI or RPI?

tgon · 11 March 2017 at 7:08PM

1. For budget planning my future costs in retirement, which ONS index should I use?
2. Can the same index be used for DB pensions that guarantee inflationary rises?
3. How certain is the state pension triple lock for, say, the next 10 years?
4. What index is implied when "the current rate of inflation " is commonly used?

Thanks in advance.

zagfles · 11 March 2017 at 7:18PM

Depends on your circumstances. For instance will you have housing costs (mortgage/rent)? One of the main problems with CPI is it doesn't include housing costs.

Also depends on your interests etc. Inflation on different things vary massively for instance if you like watching top flight football, inflation has been around 10%pa over the last 30 years, whereas if you like travel, things like flights to Europe have probably gone down in price!

DB schemes use whatever the rules say, some say RPI, others may give the trustees discretion as to what index they use.

The triple lock will likely not be safe but the most likely thing they'll ditch is the 2.5% underpin. This lacks any sort of logic and was only introduced to placate Sun readers.

number_monkey · 11 March 2017 at 7:44PM

Some good questions tgon - as you might expect, not that easy to answer:

1. Short answer - CPI (or maybe CPIH if you want), but remember that's an average across the whole country - the inflation you experience could be more or less.
Long answer - the main difference between RPI and CPI is the way they are calculated. To simplify massively, CPI makes an implicit assumption that you will substitute for cheaper goods when prices rise, and RPI doesn't. RPI is no longer considered a credible measure of inflation and is no longer a national statistic, but is still used - more below.
CPI and RPI also differ in that they include slightly different things - RPI includes mortgage interest and council tax, CPI doesn't. But there is an index that uses CPI's calculation methodology and includes housing costs - this is CPIH.
Ultimately, indices only provide a measure of how prices rise and fall in aggregate - they won't reflect any one individual's true experienced inflation. But CPI or CPIH are probably a reasonable proxy.

2. Check with your DB pension provider - the answer is probably RPI (and your pension probably won't increase by more than 5% if inflation is above that) - but each scheme is different. Watch out for this changing - I believe the government are consulting on letting schemes change from RPI to CPI. If this happens, it probably won't happen across every scheme - your scheme trustees will need to decide if they want to make the change.
[Part of the reason RPI is still used is so many pension promises and index-linked investments refer to it - there was some discussion a few years ago around abolishing it completely but how do you fairly compensate someone who bought an RPI-linked bond that is due to mature in 30 years time]

3. The government promised to keep the triple lock until 2020. But the government promised us we would remain in the single market and wouldn't increase NI. Politically watering down state pension increase promises is about as toxic as it gets and politicians make promises to people who vote, like pensioners. My hunch is it will remain until the next election (2020?) and after that, probably a commitment to retain a link to the greater of earnings and CPI.

4. When inflation is reported, it's generally CPI.

hugheskevi · 11 March 2017 at 8:26PM

Some good answers above. In addition, you may want to consider whether an inflation index is appropriate for retirement needs.

Conventional wisdom is that retirement expenditure is "U-shaped" - that is, high in the first part of retirement when most active, declining as you progress through retirement and become less active, then escalating as you have to pay for others to provide things you used to do for yourself (DIY, shopping, etc) or didn't need (care, etc).

Then there are recent studies which suggest the conventional wisdom is not accurate, and that expenditure may decline in real terms across the whole of retirement - notably this report (which I think is worth reading, whether or not you agree with the conclusions) - http://www.ilcuk.org.uk/index.php/publications/publication_details/understanding_retirement_journeys_expectations_vs_reality

kidmugsy · 11 March 2017 at 8:36PM

number_monkey wrote: »

how do you fairly compensate someone who bought an RPI-linked bond that is due to mature in 30 years time

You design a new CPI-linked Gilt with the same remaining life and you let a bidding process decide the exchange rate between old and new.

The problem would be with pension funds that had promised RPI-linking: they would reasonably want to stick to RPI-linked bonds to match their liabilities. Though HMG could always include a new gilt that offered to pay index-linking at a rate of (CPI + 1 percentage point); that would probably track RPI well enough that people might be happy to accept a trade in large numbers.

kidmugsy · 11 March 2017 at 8:39PM

By the way the triple lock is guaranteed only to 2020.

tgon · 12 March 2017 at 12:51PM

Great response - many thanks. The linked article was very interesting.

pennystretcher · 12 March 2017 at 4:41PM

It depends your pension plan. Personally I project on both - 0% growth and then CPI (and former investments I KNOW are tied to RPI) to be on a safe side. If the inflation project is correct, 1% CPI might be most sensible. Never count your chicks before they hatch though. Go with the worst case scenario and if things work out better than that count that as a bonus.

Budgeting - CPI or RPI?

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