Hundreds of thousands could see huge boost to pension cash as government to announce major reforms
HUNDREDS of thousands of retirees could see a big boost to their pension income under government plans, The Sun can reveal.
The Department for Work and Pensions (DWP) is preparing to reform rules around increasing older pension income in line with inflation, which could boost the amount retirees get.
Pensions minister Torsten Bell is expected to provide an update on the plans later this week, according to government sources.
Both compensation from the Pension Protection Fund and income from certain private pension schemes are likely to be affected by any reforms.
One pensions expert told The Sun that hundreds of thousands, if not millions of people could be impacted.
Currently, the income provided through modern defined benefit (DB) pension schemes and the Pension Protection Fund increases every year in line with inflation. This is known as "indexation".
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DB pensions are schemes that provide a guaranteed income for life, as opposed to saving up a pot of money for retirement.
The Pension Protection Fund (PPF) is a government scheme that savers are moved into if their DB pension scheme goes bust. The income they get from this is often referred to as compensation.
But the rules around increasing pension incomes or compensation in line with inflation only came into effect for "service accrued" after 1997.
Your service accrued is the amount of time you work for a company while being part of its scheme.
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So, for service accrued before April 6, 1997, the PPF cannot currently increase its compensation, while DB pension schemes don't have to raise members' income.
With the cost of living rising dramatically over the past few years, this has meant some retirees have seen a cut to their pension income in real terms as it has not kept up with soaring costs.
Former pensions minister Steve Webb, now partner at pension consultants LCP, explained: “Although the PPF provides a high degree of cover for people whose company pension schemes go bust, one gap in the design is for those whose service was at least partly before 1997.
"Prior to this date, there was no legal duty on pension schemes to provide inflation increases in retirement, so when the PPF was designed, it was judged that the PPF did not need to do so.
"With recent periods of high inflation, this means that some pensioners have seen a significant cut in their real living standard."
In January, the Work and Pensions Select Committee recommended that the government should improve pre-1997 indexation, and it has reportedly been considering a range of options over the past few months.
On March 31, Mr Bell responded to the committee and said the issue was "firmly on his radar".
Insiders involved in the discussions have now told The Sun that the government is on the cusp of announcing plans to reform these "indexation" rules to boost older pension income.
Mr Webb added: "Given that the PPF's finances are in robust health, there are increasing signs from government that action on this issue may be forthcoming”.
A DWP spokesperson told The Sun: “We are reviewing recommendations made by the Work and Pensions Select Committee, including on indexation of pre-1997 defined benefit pension schemes, and will respond in due course.”
How could the plans work?
Both the PPF and many private DB pension schemes currently have large "surpluses", which means they have a lot of spare cash.
A separate rule change was recently introduced to allow employers to access their pension schemes' surplus to spend, for example, on their business.
It is understood that under the plans in the works by the DWP, schemes will be asked to spend some of this surplus on improving their members' pension income.
A number of options are being explored, including mandating that the PPF spends some of its surplus on increasing members' pre-1997 compensation.
For private DB pension schemes, the government is considering asking them to use their surplus to boost pre-1997 income for their members if they plan to access the surplus for any other reason.
The government has not explored forcing private DB schemes to do this, though.
However, experts say it could ask employers to justify why they won't improve pre-97 indexation if they plan to use their surplus.
It is unclear what the final plans will look like and when they would come into effect at this stage.
What is pension indexation?
Pension indexation means that the value of pension income should never fall in real terms because the cost of living rises.
To maintain this, the income usually increases each year in line with a measure of inflation, such as the Consumer Price Index (CPI) measurement or the Retail Price Index (RPI) calculation.
Schemes are typically allowed to decide which measurement they use to increase their members' incomes each year.
However, there are some caps in place. For example, for pension rights accrued between April 1997 and April 2005, the maximum annual increase is currently 2.5%.
But for pension rights accrued before April 1997, there is no automatic right to have those benefits increased each year.
Some private schemes may choose to do so, but this is at their discretion.
If you have pension rights spanning a long period of time, ie. because you have worked for companies with DB schemes throughout your career, you may have differing increases for benefits accrued over different time periods.
Changes to indexation rules could significantly increase the amount you get because income accrued before 1997 will have to rise every year rather than stay the same.
For someone with an annual pension income of £20,000, a 2.5% increase on the whole amount would add an extra £500 a year to their pension, for example.
If you are not sure what your pension schemes' indexation is or what kind of pension you have, contact your pension provider or speak to your employer.
Your company's HR should have information about your pension if you can't find your paperwork.
What else is going on with pensions?
Pensions have been a hot topic over the past few years, with a number of reforms announced by the government.
The government announced a landmark pensions review last year that aimed to boost retirement income for millions of people by an average of £11,000, although this has been delayed.
There are also ongoing discussions around how a landmark court case last year could affect DB pension schemes, after it found Virgin Media had not got changes to its pension scheme signed off correctly.
Pensions are often the subject of administrative errors, too.
For example, the DWP is currently working through several state pension errors that have left retirees out of pocket.
One of those is the Home Responsibilities Protection (HRP) error.
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HRP was a scheme to protect parents who were not able to earn and pay National Insurance because they were raising children.
And last week, it was revealed that thousands of NHS workers could miss out in retirement after a major blunder which meant they did not receive vital paperwork by the correct deadline.
What are the different types of pensions?
WE round-up the main types of pension and how they differ:
- Personal pension or self-invested personal pension (SIPP) - This is probably the most flexible type of pension as you can choose your own provider and how much you invest.
- Workplace pension - The Government has made it compulsory for employers to automatically enrol you in your workplace pension unless you opt out.
These so-called defined contribution (DC) pensions are usually chosen by your employer and you won't be able to change it. Minimum contributions are 8%, with employees paying 5% (1% in tax relief) and employers contributing 3%. - Final salary pension - This is also a workplace pension but here, what you get in retirement is decided based on your salary, and you'll be paid a set amount each year upon retiring. It's often referred to as a gold-plated pension or a defined benefit (DB) pension. But they're not typically offered by employers anymore.
- New state pension - This is what the state pays to those who reach state pension age after April 6 2016. The maximum payout is £203.85 a week and you'll need 35 years of National Insurance contributions to get this. You also need at least ten years' worth to qualify for anything at all.
- Basic state pension - If you reach the state pension age on or before April 2016, you'll get the basic state pension. The full amount is £156.20 per week and you'll need 30 years of National Insurance contributions to get this. If you have the basic state pension you may also get a top-up from what's known as the additional or second state pension. Those who have built up National Insurance contributions under both the basic and new state pensions will get a combination of both schemes.