I am aged 63, and will start to collect my work pension in two years’ time. I have a defined benefit scheme which I left about a year ago after working for the company for about 35 years, as well as a SIPP.

I wanted to check if the pension I get from the defined benefit scheme will increase each year? And if so, will that be by inflation?

Paul

Rachel Vahey, AJ Bell Head of Public Policy, says:

On the face of it this sounds a simple question. But the answer isn’t necessarily straightforward.

Let’s start by explaining some of the jargon. A defined benefit scheme promises to pay a pension based on an individual’s salary and length of service. This is paid from the retirement age for the scheme. But schemes will allow people to take their pension early, from age 55, although the pension paid will probably be reduced. You may also be able to take your pension later than the scheme’s retirement age.

Sometimes, a separate cash lump sum is paid alongside the pension, or, more commonly, you may be able to exchange some of the pension for a cash lump sum (which means your annual pension will be reduced). This is also known as ‘commutation’.

IT DEPENDS ON THE INDIVIDUAL SCHEME

The guiding principle for many questions about defined benefit schemes is it depends on the particular pension scheme’s rules. So, it’s always best to check with your pension scheme in the first instance and they can tell you exactly how it works for your personal circumstances.

However, I can give you some information about the rules for increasing pensions once they start to be paid out. I’ll start by explaining the legal minimum increases to pensions that a defined benefit pension scheme has to apply.

The time you were working for the company when you were a member of the pension scheme is called ‘pensionable service’. If you have any pensionable service on or after 6 April 1997 then the pension built up in this time has to increase each year in line with prices. The increase is capped at 5% for any pension built up between April 1997 and April 2005 and capped at 2.5% for any pension built up after that time. (Another bit of jargon for you - this cap is called LPI (limited price indexation).)

If you have any pension built up from service before April 1997 then generally that does not have to increase each year. However, some people may have, as a small part of their benefits, a GMP (guaranteed minimum pension) (which may have built up when they were contracted out of the earnings-related part of the state pension). If this is the case then any GMP built up between April 1988 and April 1997 must increase in line with prices, capped at 3%.

The legislation setting these minimum increases does not specify which measure of inflation should be used. Instead, it says the ‘percentage increase in the general level of prices in Great Britain’.

Since 2012 the government has said that the inflation rate should be CPI (consumer price index). Before this the RPI (retail price index) was used. Many private pension schemes have not changed their rules since 2012 and continue to use RPI when working out the increases to the pensions in payment. This is good news for pension scheme members as RPI is usually higher than CPI.

SOME SCHEMES ARE MORE GENEROUS

These are the legal minimum increases, but the scheme may offer more generous increases. For example, it may increase the whole pension at the same rate, including that built up before 1997, even though it doesn’t have to. It may also apply discretionary increases in addition to the legal minimum. In this case, it would be up to the trustees each year to decide what the increase should be. This would be based on the funding position of the scheme, and how much money it has in excess of that needed to cover the pensions and lump sums it is going to pay.

As I said above, the best idea is to contact your pension scheme and find out how it approaches increases in pension. You can also check your handbooks and other scheme documents or online sources. Your benefit statement may also detail the increases.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to askrachel@ajbell.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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