The government has launched a consultation on the rules governing how private pensions are safeguarded against inflation.
Under the proposals, some private schemes may be allowed to use the consumer prices index (CPI) to proof pensions against rises in the cost of living.
Traditionally, schemes have been using the retail prices index (RPI) as the measure of rates of inflation.
However, the CPI increases at a slower rate than the RPI, so the move could help to save funds money but may also mean lower pension payments.
Since the CPI was introduced in 1996, it has been lower than the RPI by an average of 0.83 per cent.
The reason is that the CPI measures changes in the prices of different items, ignoring mortgage interest payments, council tax and buildings insurance.
The Office for Budget Responsibility estimated that the gap between the two could extend to an average spread of 1.2 per cent over the next five years.
Given a retirement period of 20 or 30 years, that divide could make a significant reduction in the value of pension incomes.
Around 60 per cent of private sector pensions include terms that insist pension payments must rise in line with the RPI each year.
But the consultation, issued by the Department of Work and Pensions (DWP), could enable some schemes to adopt the CPI instead as a measure of inflation.
However, Steve Webb, the Pensions Minister, told MPs that private sector pension funds would not be forced into making a switch and could not do so if the terms of the trust does not allow them to adopt CPI for their inflation uprating.
The Minister said: “We do not plan to grant schemes a modification power, to make it easier to use CPI, where they do not already have the power to amend scheme rules.
“We believe that members’ trust in schemes and the scheme rules would be severely damaged if we intervene to give schemes the power to change their rules if the scheme does not already have such a power.”
At present, the law by and large prevents employers and trustees from altering the terms of the fund in order to reduce the value of pension pots that have already been accrued.
Instead of amending the rules, the consultation proposes making the use of the CPI as a minimum requirement for increasing pension payments.
Employers will also be obliged to consult employees should they have the power to change the method of inflation uprating.
In a radio interview, Mr Webb said: “If a scheme’s rules say that a pension is protected by the RPI, then that should continue to be the case.
“If someone joined a pension scheme, and its rules said that the pension would be protected by the RPI, an the scheme does not currently have the power to change its rules, we are not going to change that.”
The Coalition Government has already confirmed that public sector pensions will be making the swap to the CPI rate of inflation when it comes to calculating by how much pensions should rise annually.
Roger Turner, of campaign group, the Occupational Pensioners’ Alliance, said: “Over 15 or 20 years, switching to CPI will make a substantial difference to pensioners’ incomes.
“Ministers say CPI is better for pensioners, but how can that be when CPI is consistently lower than RPI? It’s better for companies and better for the Treasury, but it’s worse for individual pensioners.”
But the government stood accused by Joanne Segars, chief executive of the National Association of Pension Funds (NAPF), of confusing the issue by not obliging employers to move from the RPI to the CPI for uprating purposes as had once appeared the case.
She said: “The government has marched us up to the top of the hill and is now marching us back down again. It is hugely, hugely confusing for schemes.”
There are around 5 million people now drawing a pension from private sector schemes and another 6.6 million members who have left jobs with pension rights but not yet retired.
According to NAPF just under two thirds of private pension schemes will remain linked to the RPI as they are legally bound to observe the higher measure of inflation.
But as many as 4 million members could see their pension upratings changed as RPI is not hardwired into the rules governing their schemes.
A switch to CPI could shave as much as 15 per cent off the value of a pension, industry experts have estimated.
The consultation will close on 2 March 2011.
