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Adjusting for inflation

08 November 2017

High inflation is a talking point for households across the UK, but while it is bad news for some, it is better news for others.

With wage growth now tracking well behind inflation, and cuts to in-work benefits, the financial pressure on low- to middle-income households shows no signs of abating. Those who are ‘just about managing’ could be more accurately described as ‘struggling just to get by’.

Yet for certain individuals, the recent rise in inflation isn’t necessarily bad news. This is because UK consumer price inflation in September is used for the indexation of the State Pension, public-sector pensions and the lifetime allowance, with increases being applied on or after 6 April next year.

The Consumer Prices Index (CPI) rose to 3% over the 12 months to September1 – the highest rate in five years. Because of this, pensioners should see their State Pension grow significantly thanks to the ‘triple lock’, which ensures that payments increase by the higher of growth in average earnings, CPI or 2.5%.

With average earnings going up by just 2.1%2, it looks likely that the higher 3% CPI figure will be used to uprate pay-outs from 6 April next year. This will be equivalent to around £250 a year for those in receipt of the full single-tier State Pension.

Meanwhile, many of those working in the public sector will enjoy above-inflation increases in pension entitlements for next year, despite seeing their income stagnate under the current pay freeze. The September CPI figure is used as the basis for uprating public-sector pensions, such as those paid to teachers, the police and NHS staff. The NHS Pension applies an increase of CPI plus 1.5%, so its members are likely to see a 4.5% rise in their accrued benefits.

The lifetime allowance is also due to be indexed for the first time in April 2018. The lifetime allowance is an overall limit on the value of pension savings that can be drawn without triggering an extra tax charge. This has been cut three times over the last five years. The 3% CPI figure means that pension savers should see it climb to £1,030,000. That increase will cut the lifetime allowance excess tax charge by up to £16,500, and could boost tax-free cash by £7,500.

Paying the price

The cost of upping state benefits, combined with the increase to the lifetime allowance, inevitably brings the issue of intergenerational fairness under the spotlight once again. Younger people have experienced the tightest squeeze on household spending in recent years3, so some will question whether it is fair to ask them to pick up the bill through their taxes.

Furthermore, given the current pressures and uncertainties in the UK economy, the affordability and sustainability of state benefits and tax exemptions will doubtless come under scrutiny ahead of the Budget on 22 November.

Nevertheless, any attempt by the chancellor to squeeze cash from pensioners will most likely be met with resistance by Tory backbenchers. He has already been warned that rises to the State Pension should not be seen as an excuse for a raid on people’s private pension pots, while any package of age-related tax increases would be deeply unpopular.

“Mr Hammond has been dealt a very tricky hand indeed,” says the Institute for Fiscal Studies.

“The political arithmetic makes any significant tax increase look very hard to deliver. It looks like he will face a substantial deterioration in the projected state of the public finances. He will know that seven years of austerity have left many public services in a fragile state. And, in the known unknowns surrounding both the shape and impact of Brexit, he faces even greater than usual levels of economic uncertainty."

 

The levels and bases of taxation, and reliefs from taxation, can change at any time and are dependent on individual circumstances.

 

1 Office for National Statistics, Consumer Price Inflation, September 2017

2 Office for National Statistics, Average Weekly Earnings, September 2017

3 Resolution Foundation, Consuming Forces, 30 September 2017

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