I am an 80-year-old pensioner and was recently contacted by my pension fund manager about future annual pension rises. I was asked to make a choice between a guaranteed annual increase of three per cent or the rate of inflation up to a ceiling of five per cent.

I opted for the inflation rate up to five per cent. I based my decision on RPI, which has been rising, but now understand that my pension scheme rises are based on CPI which, for some reason, seems to be falling, down from 3.1 per cent to 2.5 per cent. Have I made a bad decision?

You have not made a bad decision! The fact that your pension will increase is great news and will ensure that the buying power of your pension will remain reasonably consistent over time.

Inflation figures are calculated in a number of different ways and the Consumer Prices Index (CPI) forms the basis for the Government’s inflation target. This was set at an annual rate of two per cent in December 2003 and is also an internationally comparable measure of inflation, published in the UK until December 2003 as the Harmonised Index of Consumer Prices (HICP).

Although the name has changed, the CPI and HICP remain one and the same, calculated according to rules specified in a series of European regulations.

The CPI uses essentially the same basic price data as the RPI but differs from it in some important respects, for example:

• the goods and services covered by the index. For instance, the CPI does not include council tax and a number of housing costs faced by homeowners. But there are also some services covered by the CPI â“ such as charges for financial services â“ which are not in the RPI.

• the people whose expenditure is covered by the weights. The CPI covers a broader population than the RPI.

• the mathematical formulae used to calculate the price changes for the most detailed components of the two indices. In practice, this means that the CPI always shows a lower inflation rate than the RPI for given price data.

• the way in which the goods and services are classified.

The CPI follows international definitions while the RPI has its own specific structure, which results in differences.