The government's decision to cut the value of Limited Price Indexation (LPI) by half could significa...
The government's decision to cut the value of Limited Price Indexation (LPI) by half could significantly shrink future pensions if there would be a return of higher inflation rates, Insurance Marketing Department (IMD) says.
This comes as Pensions minister Andrew Smith proposed last month to reduce LPI - introduced in 1997 to provide protection from inflation - from 5% to 2.5% in a bid to ease the cost burden on pension schemes.
IMD believes this could have a major impact on the future value of pensions if inflation were to increase.
However, this will not only affect people receiving a pension but also those people still working who have preserved pensions from previous employments, IMD claims.
At the moment, a person with a saved pension of £20,000 a year – with another ten years to go until retirement - could expect a pension of £31,026 a year.
But if the same prospective pension increased by 2.5% a year, the pension would only be worth £24,977 – over £6,000 a year less - IMD deems.
This problem becomes worse the longer the time to retirement is says Stephen Phillips, managing director of IMD, and adds that "the gap widens progressively so that, after 15 years, the annual pension shortfall is more than £11,000 a year.
And, worryingly, "if the time to retirement at age 60 is fifteen years", Phillips says, "a fund of more than £200,000 would be required to fill the gap."
He also points to the fact that average earnings tend to rise at a faster pace than prices, adding that even keeping in line with inflation "almost guarantees" that spending power in retirement will increase at a slower pace than earnings.
He adds that: "This will now be even more pronounced, as LPI is limited to a level that is far below the rate of wage inflation – which has averaged almost 3.75% a year over the last five years. This will result in deferred pensioners becoming progressively worse off, compared with those still actively building up benefits under defined benefit schemes."
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