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What zero inflation could mean for you; In association with lloydstsb.com/corporatemarkets.

One of the key measures of inflation fell to zero during February and it looks set to slide into negative territory during the coming months.

Figures released yesterday showed inflation measured by the Retail Prices Index (RPI) fell to zero per cent last month, down from 0.1 per cent in January.

But while falling prices may seem to be good news for consumers, having RPI inflation at below zero could lead to lower incomes for pensioners and reduced returns for savers.

Here is how negative RPI would impact various financial products:

State pension

The basic state pension is increased every year in line with the level of RPI in September. The Government states that the state pension will rise by either RPI or 2.5 per cent, depending on which is greater. As a result, even if RPI stays at zero or turns negative, pensioners will still see their income from the basic state pension increase by 2.5 per cent.

But the latest inflation figures are still bad news for pensioners. Inflation for retired people is currently much higher than for the rest of the population because they spend a higher proportion of their income on food and fuel. Research suggested that average pensioner inflation reached 5.4 per cent in January.

Other benefits

Many other benefits also rise annually in line with RPI. The Department for Work and Pensions (DWP) said no decision on what would happen to these benefits had yet been taken, but it stressed that they would not be reduced if inflation turned negative in the coming months. Instead a decision will be taken in November or December about whether to keep the levels at which the benefits are paid on hold in the following April, or to increase them.

People who saved for their retirement through a personal pension and used their pension pot to take out an index linked annuity when they retired will not receive a rise in their income with RPI at zero, and some may see their pension fall if the UK suffers a period of deflation.

Index-linked annuities track the RPI measure of inflation, and while some of the products have a floor in place to protect holders if inflation turns negative, others do not.

Unit-linked annuities from Axa, Legal & General, MGM Advantage and Norwich Union all have floors in place.

But people who bought an index linked annuity from Partnership could see their annual income fall if there is a further drop in RPI.

The terms and conditions of index linked annuities from LV also allow for pension incomes to be reduced if RPI turns negative, although the group said it currently had no plans to reduce them.

However, it plans to keep the issue under review. People who bought an annuity from Standard Life before 1997 will be protected if RPI turns negative, but those who bought annuities after this date will see their income fall.

Occupational Pensions

People with occupational schemes should not suffer a drop in their income if there is deflation. The majority of work based pension schemes have a floor of zero per cent on their index-linking, meaning that people's incomes cannot fall even if RPI becomes negative.

Index-Linked Savings

People with National Savings and Investments' Index-Linked Savings Certificates will receive lower returns with RPI at zero. The product can be taken out over a three-year or five-year term, with returns calculated on an annual basis, according to the level of RPI the month before the anniversary of when the product was taken out, compared with a year earlier. If inflation is negative during this period, the value of the investment does not fall as negative inflation is not applied to the policies. But no index-linking will be added to the policy either, although it will still benefit from a guaranteed compound rate of interest.

Student Loans

There are two types of Student Loans, those taken out before 1998 and those taken out afterwards.

For loans taken out before 1998 interest is set at the level of RPI in March, although the new rate does not become payable until September of that year.

Interest on loans taken out after 1998 is set at either RPI on March 31 or the highest base rate charged by a group of banks plus one per cent, depending on which is lower. As a result, interest on these loans has fallen from3.8 per cent in September last year to 1.5 per cent now. The Student Loans Company said no decision had yet been taken on what would happen to the interest charged on the loans if RPI for March was negative.
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Title Annotation:Business
Publication:The Birmingham Post (England)
Date:Mar 25, 2009
Words:777
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