Pension Increases
Most pensions (including the member's own pension and any provisions provided for spouse/dependants) increase during payment. This is often referred to as escalation.
The nature and frequency of any pension increases depend primarily upon the type of pension scheme, and the rules of the particular scheme.
A pension in payment may for example, be increased so as to offset or partly offset rises in the cost in living (by reference to the Retail Prices Index (RPI)).
There are also however a number of statutory requirements, outlining the minimum pension increases payable by pension schemes in defined circumstances.
The exact level of pension increase can therefore depend upon a number of factors, such as:
- the exact nature of the pension scheme -- is it a company pension scheme or some form of individual arrangement, such as a personal pension scheme?
- the exact dates the member joined and left the scheme;
- the date the pension commenced payment; or
- the choices made by the member at the time the pension is set up.
Given below is a brief description of some of the circumstances, in which there are requirements for pension schemes to increase pensions in payment.
We would stress that this area of pension provision is very complicated, and it is not possible for our summary to be comprehensive. Please therefore see our Q&A section below.
If you need further clarification, you can check the situation in relation to your own pension scheme by examining scheme documents (such as the pension scheme booklet), or by contacting your pension scheme administrators.
Alternatively, for general guidance, please feel free to contact us.
Occupational Pension Schemes - Final Salary
The Pensions Act 1995 required occupational pension schemes to provide increases to pensions in payment in line with RPI to a maximum of 5% (known as Limited Price Indexation (LPI)). This provision for LPI only applies to benefits earned after 6 April 1997 (AVCs are exempt).
This requirement has now been amended, so that that part of the pension earned after 6 April 2005, only needs to be increased in line with RPI, up to a maximum of 2.5%.
However, for that part of the pension earned before 6 April 1997, while scheme rules may grant annual increases, there is no legislation that requires schemes to increase this pension unless the scheme was contracted-out of the State Earnings Related Pension Scheme (SERPS).
The rules of contracting-out require that increases be applied to the GMP as follows:
- no increase for GMPs accrued before 6 April 1988; and
- for GMPs accrued between 6 April 1988 and 5 April 1997, the annual rate of increase is the RPI, subject to a maximum of 3%.
We would stress however that these are only the minimum requirements, and it is normally possible for the rules of company pension schemes to provide for a higher level of pension increase.
Occupational Pension Schemes - Money Purchase
For most benefits earned under money purchase occupational pension schemes before 6 April 1997, there is no statutory requirement for pension increases to be provided.
Members are normally however allowed to request annual pension increases of (for example) 3% or 5% when their scheme benefits are in the process of being set up, though this will reduce their initial pension level.
For benefits earned under money purchase occupational pension schemes after 6 April 1997, which came into payment before April 6, 2005, the Pensions Act 1995 required occupational pension schemes to provide increases to pensions in payment in line with RPI to a maximum of 5% (known as Limited Price Indexation (LPI)).
There is no statutory requirement for pension increases to be provided on benefits under money purchase pension schemes, which come into payment after 6 April 2005 (though there might be such a requirement under the pension scheme rules).
For occupational schemes contracted-out on a money purchase basis, the part of the pension bought by contracted-out contributions (known as Protected Rights) prior to 5 April 1997 must increase in line with the RPI, subject to a maximum of 3% p.a., whereas the pension bought by post 6th April 1997 protected rights payments must increase in line with LPI (capped at 5%).
Personal and Stakeholder Pensions
For a large proportion of the benefits available on the personal or stakeholder pension schemes, the level of pension increase payable is chosen by the scheme member upon the setting up of the benefits.
The higher the level of pension increase chosen, the lower the initial pension level will be (as it costs more to provide a pension, which increases in the future).
There are still however some statutory provisions that apply to personal and stakeholder pension schemes. The increases (if any) that apply to both are similar but there are differences. Each is outlined below:
Stakeholder Pension Schemes
For trust-based stakeholder pension schemes (of which there are very few), which came into payment before 6 April 2005 the LPI requirements of the Pensions Act 1995 apply. Increases must be provided to pensions in payment in line with RPI to a maximum of 5% (known as Limited Price Indexation (LPI)).
For trust-based stakeholder pension schemes which come into payment after 6 April 2005, there are no statutory requirements for pension increases. Policyholders are free to choose the level of increases applying in retirement.
Personal pension schemes
Since April 2005, there have been no statutory requirements for pension increases. Policyholders are therefore free to choose the level of increases applying in retirement.
- How are pension increases for a member who is in receipt of a pension from an occupational final salary pension scheme normally calculated?
Retirement prior to April 1997
The pension from a final salary scheme for a member who retired prior to April 1997 comprises of 3 elements:
- Post 1988 GMP (earned between 6 April 1988 and 5 April 1997);
- Pre 1988 GMP (earned between April 6, 1978 and April 5, 1988); and
- Non-GMP (benefits in excess of GMP).
Increases to post 1988, pre 1988 GMP and non-GMP are different.
For post 1988 GMP and pre 1988 the member receives inflation-proofed increases. However for post 1988 GMP the scheme is responsible for only the first 3% of the inflation increase. If inflation is less than 3% then the member will receive the increase entirely from the scheme (which will be less than 3%). If inflation is more than 3% then a 3% increase is paid by the scheme whilst the remainder is added to the state pension.
For pre 1988 GMP the whole of the increase is paid by the state as an addition to the state pension.
For pension based upon service prior to April 1997 there is no legal requirement for schemes to increase the non-GMP for pension in payment (though there could be some provision for some increase on this portion of the benefits under the pension scheme rules).
Retirement after April 1997
The comments in relation to GMP above also apply. However, the non-GMP pension is split between that based earned after April 1997 service and that based upon pre April 1997 service.
The element of non-GMP pension earned between 6 April 1997 and 5 April 2005 must increase by 5% per annum or the change in the Retail Price Index if less (this is known as Limited Price Indexation or LPI for short).
For the remaining non-GMP pension (i.e. that based upon pre April 1997 service) there is no legislative requirement compelling schemes to provide increases (though again there could be some provision for some increase on this portion of the benefits under the pension scheme rules).
This requirement has recently been amended, so that that part of the pension earned after 6 April 2005, only needs to be increased in line with RPI, up to a maximum of 2.5%.
Again, it is possible that the particular company pension scheme rules will provide for a higher level of increase.
- How are pension increases for a member who is in receipt of a pension from an occupational money purchase scheme normally calculated?
The pension from a contracted out money purchase scheme will comprise two elements:
- Protected rights; and
- Non-protected rights.
Protected Rights arise as a result of the scheme contracting out of the additional tier of the government's state pension provision, previously known as the State Earnings Related Pension Scheme (SERPS), and now called the State Second Pension (S2P).
The pension in respect of Protected Rights contributions paid prior to April 1997 must increase by 3% per annum or the change in the Retail Price Index if less. This increase is paid by the scheme.
The pension in respect of all contributions paid between 6 April 1997 and 5 April 2005 must increase by 5% per annum or the change in the retail price index if less (this is known as Limited Price indexation or LPI for short). This increase is paid by the scheme.
There is no statutory requirement for pension increases to be provided on benefits under money purchase pension schemes (no matter where they were earned), which come into payment after 6 April 2006 (though there could in theory still be such a requirement under the pension scheme rules).
- How are pension increases for a member who is in receipt of a pension from a Personal Pension or Stakeholder pension scheme normally calculated?
For a large proportion of the benefits available on the personal or stakeholder pension schemes, the level of pension increase payable is chosen by the scheme member upon the setting up of the benefits.
The higher the level of pension increase chosen, the lower the initial pension level will be (as it costs more to provide a pension, which increases in the future).
There are still however some statutory provisions that apply to personal and stakeholder pension schemes. The increases (if any) that apply to both are similar but there are differences. Each is outlined below:
Stakeholder Pension Schemes
For trust-based stakeholder pension schemes (of which there are very few), which came into payment before 6 April 2005 the LPI requirements of the Pensions Act 1995 apply. Increases must be provided to pensions in payment in line with RPI to a maximum of 5% (known as Limited Price Indexation (LPI)).
For trust-based stakeholder pension schemes which come into payment after 6 April 2005, there are no statutory requirements for pension increases. Policyholders are free to choose the level of increases applying in retirement.
Personal pension schemes
Since April 2005, there have been no statutory requirements for pension increases. Policyholders are therefore free to choose the level of increases applying in retirement.
- Is there any statutory requirement to increase pensions arising from AVCs or FSAVCs?
No. The member chooses when selecting their benefits, whether to include an allowance for any pensions arising from the schemes to increase in payment.
If the member selects a pension, which increases in payment, the initial amount will be lower.
- How do State pensions increase?
State pensions currently usually increase each April by the change in the Retail Price Index over the 12 months to the end of the previous September.
The government has recently announced an intention to re-establish the link between state pension increases, and the increase in average earnings (which is normally higher than the increase in inflation), by 2012 if possible, and by the end of the next Parliament at the latest.
Q & As
