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 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.
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.
Occupational Pension Schemes - Final Salary and Career
Average
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 Guaranteed Minimum Pension
(GMP) as follows:
- no increase for GMPs accrued before 6 April 1988 (but increases
on these are paid by the government along with the State Pension);
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)).
For occupational schemes contracted-out on a money purchase
basis, again for pensions which came into payment prior to the 6h
of April 2005, 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.. The pension bought by post 6th April 1997 protected
rights payments must increase in line with LPI (capped at 5%).
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).
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.
Q & A's
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.
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 2005 (though there could in theory still be such a
requirement under the pension scheme rules).
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.
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.
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.
