RPI/CPI calculation help needed

claire111

Hi

I was considering purchasing Additional Pension (NHS) sometime 'during the next few years' but the way that it will be calculated will change with applications received after 31st March, so I have to decide now whether to do it earlier than I had anticipated

I'm not being lazy, I've read all the threads but I just can't get my head round this. Can anyone help ?

If I purchase say £1,000 of extra pension (in today's money) it will cost me a one off payment of £10,700 and become payable in 17 years time. I think this represents good value but;

If I apply for it before 31st March it will increase by RPI until payable and then will increase by CPI.

If I apply for it after 31st March it will increase by CPI before and after it is payable.

Is the change to 'increase in line with CPI' before it is payable going to make a whole lot of difference ?

Thanks for your thoughts

Claire

jrawle

RPI is generally higher than CPI, which after all is why the government want to switch to CPI: it's cheaper. RPI tends to run higher because it includes mortgage costs. However, in the last couple of years, there have been periods when CPI has been higher due to the recession and slump in the property market.

All else being equal, I'd say go for RPI if you can, particularly as you'll benefit from it for 17 years as the additional increase will compound over all those years.

This PDF explains the difference between the indices:
http://www.statistics.gov.uk/downloads/theme_economy/cpi-rpi-information-note.pdf

This chart shows the values for the last few years:
http://www.statistics.gov.uk/cci/nugget.asp?id=19

Loughton_Monkey

You really need a crystal ball to determine it accurately.

Imagine that CPI is 3% and RPI is 4%. Simply put 10000*1.03^17 into excel and you get 16528.
Put in 10000*1.04^17 and you get 19479. That's almost 18% better.

So pick what you think CPI and RPI will be and try a calculation or two. Compounding is very powerful.

claire111

Thanks for this, but I am still struggling

I understand compound interest on savings......

I sort of remember studying the house price index in the 90's....

But I am buying a fixed amount of pension of £1000. Will it be compounded ? It's not a fund or anything.

Won't they just decide what £1000 buys today and then in 17 years time decide what it would cost to buy the same goods and uprate my £1000 by said amount ?

This is the small print;

Q. Is AP index linked?

A. Yes, AP purchased is increased in line with monthly increases in the ate of inflation both before the AP comes into payment ("a pre-payment increase") and also whilst it is being paid ("an in-payment increase"). If the application to buy AP was made:

• On or before 31 March 2011 - it will attract pre-payment increases in line with the Retail Prices Index (RPI) and in-payment increases in line with the Consumer Prices Index (CPI).
• On or after 1 April 2011 - both the pre-payment and the in-payment increases will be in line with the CPI.

Thanks for any help

Loughton_Monkey

Where's the problem?

That Q&A you just pasted in confirms only what you (quite lucidly) explained in your original post:

• Pay it in before 31st March and your benefits will be increased by RPI for 17 years, and CPI after that.
• Pay it in later, and it will be increased by CPI from the start.

Apart from using the non-existent crystal ball to tell you what either index will do over the next 17 years, what else can be said?

claire111

Loughton_Monkey wrote: »

Where's the problem?

That Q&A you just pasted in confirms only what you (quite lucidly) explained in your original post:

• Pay it in before 31st March and your benefits will be increased by RPI for 17 years, and CPI after that.
• Pay it in later, and it will be increased by CPI from the start.

Apart from using the non-existent crystal ball to tell you what either index will do over the next 17 years, what else can be said?

I can't see why it will be compounded. It just says 'increased'. Is that the same thing ....?

Why does it not just rise by the difference on the index between 2011 and 2028 ?

I will go away and do more homework on compounding.....

JamesU

Loughton_Monkey wrote: »

Where's the problem?
what else can be said?

As in the info, perhaps the "prepayment" increases refer to indexed increases in the AVC prior to retirement and "in-paid increases" refer to AVC increases after retirement? In which case it may also be read from the information that AVC increases are indexed to RPI on a "prepayment" basis until 1st April, and after this date both prepayment and in-paid are indexed to CPI. And if so, there is no real point in worrying about trying to fix in before the April deadline as far as RPI/CPI are concerned as the purchased AVC will still be indexed by CPI for both prepayment and in-paid indexed increases from April onwards?

Think this might be worth checking out very carefully with personnel beforehand.

JamesU

Loughton_Monkey

JamesU wrote: »

As in the info, perhaps the "prepayment" increases refer to indexed increases in the AVC prior to retirement and "in-paid increases" refer to AVC increases after retirement? In which case it may also be read from the information that AVC increases are indexed to RPI on a "prepayment" basis until 1st April, and after this date both prepayment and in-paid are indexed to CPI. And if so, there is no real point in worrying about trying to fix in before the April deadline as far as RPI/CPI are concerned as the purchased AVC will still be indexed by CPI for both prepayment and in-paid indexed increases from April onwards?

Think this might be worth checking out very carefully with personnel beforehand.

JamesU

Agree worth double checking, but read the QA carefully, and it seems clear to me that they refer to the 'purchase' of the AP [which would be before or after 31st March] and the 'payment' of the AP [which can really only be the annuity payment or 'pension']

If it were as you say, James, I hardly think they would even mention it because, as you say, it would be largely irrelevant.

Just as an aside, on the 'back of an envelope', increases in line with RPI over the last 17 years would have turned £1,000 into £1,600. CPI would have turned it into £1,500.

JamesU

Loughton_Monkey wrote: »

Agree worth double checking, but read the QA carefully, and it seems clear to me that they refer to the 'purchase' of the AP [which would be before or after 31st March] and the 'payment' of the AP [which can really only be the annuity payment or 'pension']

If it were as you say, James, I hardly think they would even mention it because, as you say, it would be largely irrelevant.

Just as an aside, on the 'back of an envelope', increases in line with RPI over the last 17 years would have turned £1,000 into £1,600. CPI would have turned it into £1,500.

LM, Yes, strange, just looked ambiguous to me, maybe best check with HR. Maths straight forward as you say, using a lower 0.8% difference (if using Government's longer term prediction) over 17 yrs, around 13% lower if CPI used instead of RPI etc


Claire111, if you do not use Excel, an easy way to do your own calculations as follows:

Assume long term difference between RPI and CPI is 0.8% (Government) and over 17 yrs
Assume a pair of inflation figures, e.g. RPI = 3.0%, CPI=2.2%

Then calculate "end of term sum" from online compound calculator in link below for both RPI and CPI (automatic annual compounding, ignore the "interest received" figure)

http://www.online-calculators.co.uk/interest/compoundinterest.php

To do this, just input 3 figures into the left hand calculator for RPI, click outside of the green box and note the "end of term sum". Then do the same for CPI:

For RPI: inputs: £1000, 3.0%, 17yrs = end of term value of £1653
For CPI: inputs: £1000, 2.2%, 17yrs = end of term value of £1448

% reduction of pension value at retirement age due to switch from RPI to CPI is then:

(1653-1448)/1653 = 13% reduction in pension value at retirement date


JamesU