Of course we do pay inflation linked pensions though corporate and personal taxes, we pay for the public servants to get full CPI linkage so their wage in retirement will go up with inflation without a cap, some still get the higher RPI.
We all get full inflation and more from the triple lock of increases on our state pension
But in the private market it’s different. A few private sector pensions paid on a defined benefit basis do not cap pensions but most do at 5% or even 2.5%. The excuse for the cap is that pension funds cannot afford to increase pensions when inflation is high and growth is low (stagflation).
DC pensions have never bothered much about increasing pensions till now. Retirement Line have , since pensions stopped being compulsory, reported that 80% of pots swapped for pensions buy level annuities, a retirement wage guaranteed to go down in real terms by the rate of inflation. It is a sad state of affairs but not as bad as before 2015 when an annuity was provided, often without broking, almost always level, almost always without a spouse’s pension. It was an embarrassment to DC providers (occupational and personal pension providers) that the pot could pay so little. Pension Freedom released providers from that embarrassment.
But now things are changing. First we have CDC which will be required to target CPI in its pensions, then we have other workplace pensions who will have to offer default retirement income from next year. We haven’t seen what that increases will be built into DC default “pensions” but we know the income must be regular and last for as long as the pensioner’s alive. We don’t know about spouse or partner’s pensions either.
Were there to be consistency between CDC and DC then DC providers would have to offer by default a CPI increasing retirement income but the question is “can we , the potholders, afford a wage in retirement that goes up with inflation?”
I am told , and he may wish to comment on this, that Guy Opperman required CDC income to be linked to CPI inflation. There is no get out for CDC proprietors and trustees to pay CPI-1 and certainly no option to pay level pensions (unless times are really bad and this only temporarily).
I would expect the secondary legislation written now by the DWP teams, will require some kind of promise from DC providers, however embarrassing that will be. The regular incomes will be at around 4% (the rule) and 1/25th of your pension pot may not be an awful lot!
I imagine that spouses pensions won’t be an issue for DC – the spouse or partner will get the unspent pot under flex and fix unless in the “fix” bit when I suspect people will choose whether the annuity “fix” pays spouse’s pensions. If the flex happens from 85 (as Nest’s will) then I doubt that spouse’s pensions will be much of an issue but I may be wrong – I haven’t seen the costings.
In any case, if when the Pension Dashboard arrives , we have an alternative to SMPI, it may be the default retirement income and if that is compatible with what CDC targets, we may have a solution to a problem that exists now. Right now SMPI advertises a level annuity while CDC schemes will advertise an inflation increasing retirement income. Both will advertise an income till death and CDC will likely advertise a spouse’s pension as standard.
Can we afford it?
The simple answer is “no”. We cannot afford it because we have not paid for it in our contribution rates.
My actuary, Chris Bunford, estimates that increasing pensions both before and after when the pension is taken, costs half of the pension that is payable. Put very simply, the 50-60% extra in pension that the Government advertises for pension from a CDC lies in the value to a person living an average time and getting an inflation linked rather than a level pension.
Put another way, if CDC pensions went up with inflation and the retirement income from a DC was paid level, then the CDC would be 50% more over a retirement lifetime than a SMPI (level) projected DC pension.
It may be that DC can afford to pay higher pensions by investing in annuities right now but we must remember that current 8% level annuity rates are the result of a surge in gilt yields resulting from local and global difficulties and I doubt they will stay that way. If they do and inflation disappears the gap between buying an annuity and having a pension backed by growth assets may narrow but I suspect that that is temporary.
The sad truth is that the best we can afford from annuities is a level income that in practice goes down whenever we have inflation which is all the time.
From DC we will get smaller incomes than from CDC , if those incomes are offered as a default with inflation linking. We have yet to see the comparisons but I think Nest has the numbers.
The Nest model pays increases in retirement based on “what it can afford” which is as close to CDC as you can get. The only difference between Nest and CDC is that Nest offers greater flexibility if you want to cash out your retirement income and the rate of pension it pays relative to CDC – this may be a better difference than the “up to 60%” quoted by the DWP for CDC.
Either way, we can only get paid an income based on the amount we save and how long we do it for. That’s the same for DC and CDC , neither of which have an employer to bail them out. When we say “we cannot afford inflation”, we mean without increasing savings for the young and having inflation linked pensions elsewhere if you are old.
These are the problems for the DWP as they struggle to legislate the retirement incomes that will be defaults for DC master trusts from 2027 and single employer trusts from 2028.
If we are to be consistent with CDC, DC defaults should be targeting CPI inflation with the incomes offered. Whether people opt out of the low pensions that result (of dividing the pot by around 25) is another matter!
Opt out by people facing an inflation linked default pension from their DC pot- will be a measure of whether we can afford “real” pensions.
