For the first time since 1960 annual inflation has gone negative. In other words instead of prices rising year on year
, as they have for nearly forty years, they have fallen. So what happens to pensions, savings, tax allowances and other things which normally go up each year in line with inflation when price rises turn into prices falls? Will they be cut too? The answer is generally ‘no’. But there are exceptions.State pension
The state pension is linked to the rate of inflation in September and rises
by that percentage the following April. Last September the Retail Prices Index (RPI)
rose by 5%. So the state pension was increased by 5% in April 2009. But this
coming September prices will be falling – the Chancellor says by a post-war
record of minus 3%
Gordon Brown announced in November 2001 that the basic state pension would always rise by 2.5% even if inflation fell below that level. So even if inflation is negative in September the basic state pension will rise by at least £2.40 a week in April 2010. However, this commitment relates only to the basic state pension – which is currently £95.25 a week. It does not apply to SERPS (now called State Second Pension and officially called ‘additional pension’) or graduated retirement benefit. They will, at worst, be frozen if inflation falls below zero. Pension credit is linked to earnings and it is very unlikely that index will show a fall so it will rise in line with that index.
All other social security benefits linked to prices, including those paid to carers and disabled people will not fall below their 2009/10 values in April if inflation is negative in September
. That will happen even if by then prices are going up again. However, there has to be an election before 3 June 2010 and that will put huge pressure on politicians to make sure that the most vulnerable in society are protected. It may be worth lobbying your MP now.Tax allowances
Personal tax allowances – the amount of money we can have each year without
paying tax – are also linked to inflation. The Treasury has already indicated
that in 2010/11 the personal tax allowance will remain the same as 2009/10 at
£6,475. The higher rates for those aged 65 or more will also probably be frozen
in 2010/11. However, for 2011/12 the allowance for those over 75 will be at
least £10,000 due to a commitment given some time ago by the Chancellor. The
level at which higher rate tax begins will also be frozen in 2009/10. The
threshold for Inheritance Tax is not linked to inflation and the Government has
already announced it will rise to £350,000 in 2010/11. The threshold at which
National Insurance contributions begin is linked to the state pension so that
may rise in 2010/11 with the small increase in the state pension. We will not
know definitely what is happening until the Pre Budget Report in the Autumn and
the Budget next Spring.
Annuities
If you have already bought an annuity – a pension for life from an insurance
company – you might have chosen one which rose in line with the Retail Prices
Index. Annuities that are linked to inflation may go down if inflation is
negative. Others will simply stay frozen. It depends on the small print. Some
insurers, worried about the bad publicity of cutting the pension they pay, have
already said that their annuities will not be reduced even if the terms and
conditions say they could be. Instead
Company pensions and those paid by public authorities which rise in line with inflation will generally be frozen if inflation is negative.
National Savings
Many people have put their money into index-linked National Savings
certificates. These pay out after three or five years and promise that the value
of your money will have risen by inflation plus a guaranteed 1% a year. If
inflation goes negative, National Savings will always count it as zero. The
interest is added each year on the anniversary of the month the certificate was
purchased. So if inflation is negative on that anniversary you will get the
guaranteed percentage but nothing for inflation. The guaranteed percentages vary
from year to year but works out over the term of the certificate at 1% per year
compound.
Gilts
The other popular sort of inflation linked savings product is Government
stock or ‘gilts’ (which is short for ‘gilt-edged securities’). The rate of
interest and the final value of the bond are both linked to the RPI. So 2.5%
index linked stock pays a rate of interest which is 2.5% increased with RPI
since the gilt was issued. If inflation falls the rate of interest and the half
yearly dividend payment will be less than it was in the year before. But for the
final value to fall inflation would have to be negative for the life of the gilt
– a very unlikely event.
Price indexes
There are two main measures of inflation. One is called the Retail Prices
Index (RPI) and has been around since 1947. A newer measure called the Consumer
Prices Index (CPI) is favoured by the Government, not least because it is used
throughout Europe and much of the world. The Bank of England has a target of
keeping CPI at 2%. But because RPI is older, anything which is linked to
inflation normally follows the RPI.
The two indices are different. Financial services and university fees are in the CPI but not the RPI. Housing costs such as mortgages and council tax are in RPI but not the CPI. The inflation experienced by the richest households and by low income pensioners are excluded from the RPI but CPI includes them. And the maths used to work out the two indices is different.
Neither index reflects the change in prices for any individual. That relates to what they spend their money on. Research by the Institute for Fiscal Studies found that prices in February 2009 were falling for the richest third of households. But were rising well above official inflation rates for the poorest third. Generally the older you are and the lower your income, the higher your own rate of inflation. That is because you will spend more on food, fuel, and other essentials which have been rising strongly.
Price rise history
Prices fell at the start of the 19th century and although they went up and down slightly over the century they were at the same level in 1913 as they were 80 years earlier in 1833. They rose sharply during World War I and reached a peak annual inflation rate of 25.4% in 1917. But then they began to fall in the 1920s dropping more than a third between 1920 and 1934, which included the Great Depression. After that prices have risen year on year ever since, apart from a few months of deflation at the end of 1959 and early 1960
. The two high spots of inflation were in August 1975 when it peaked at 26.9% and in May 1980 when it hit 21.9%. In September 1990 it rose to 10.9%. Today the RPI shows prices 17 times higher than they were in 1960. In other words something that cost a pound then will cost slightly more than £17 now. Having a fiver in your pocket then was like having £85 now. And a fiver today will buy you what 5s 10d (29p) would then.June 2009