Inflation and your occupational pension

We often call them ‘gold-plated’: good company pensions that are related to your pay and the number of years you have paid in and, from retirement, are protected against inflation. For many years all that has been true. But the current high and rising rate of inflation will mean these gold-plated pensions will no longer gleam quite so brightly. That is because the annual inflation rise is capped – partly at 5% and partly at 2.5%. With inflation already over 9% and rising, the annual increase in the next 12 months will be limited by the caps and the 10 million people with one of these pensions will no longer have their incomes fully protected against rising prices.

Like everything to do with pensions, the way these company schemes take account of inflation is complicated.

The law says that any pension in payment that relates to service from April 1997 to April 2005 must be raised once a year with inflation, subject to a cap of 5%. In other words, if inflation exceeds 5% the annual pension increase will be limited to 5%. The cap for pensions based on service from April 2005 is much lower – just 2.5%. So if inflation exceeds that level then the increase on that part of the pension will be 2.5%. Pensions relating to work before April 1997 do not have to be raised at all. So your pension could be in three parts: an increase with inflation capped at 2.5% on the pension earned at work since 2005; a rise capped at 5% on pension earned in the eight years before that; and no rise at all on any pension earned before April 1997.

Those are just the legal minimums. Many pension schemes do increase pensions earned before April 1997 with inflation. And trustees have the discretion to pay more than the cap if they choose. If your pension rise this year is less than the actual rate of inflation – as it almost certainly will be – your union or staff association can ask the trustees or the sponsoring employer for an increase above the cap. That plea may of course be ignored.

For many years these caps did not matter too much, as inflation was below 5% from 1997 to 2005 and mainly below 2.5% since then. Even when it exceeded 2.5% the difference was not that great. But inflation has taken off in the past few months, which will mean even those with gold-plated pensions will end up poorer.

RPI or CPI

Just to complicate things further there are two different ways pension schemes measure inflation. Until 2011 they all used the RPI or Retail Prices Index. But from that year the Government adopted a new index for benefits and the state pension: the CPI or Consumer Prices Index, which is used for the headline rate of inflation announced each month on news bulletins. CPI is always lower than RPI. June, for example, showed prices rising by 9.4% according to the CPI but inflation was higher at 11.8% as measured by the RPI.

Over the past decade many schemes changed from RPI to CPI because it saved them money. However, many that wanted to change found they could not, because the trust deed that set them up specified they should use the RPI. If the trust deed did not specify an index and just said pensions should rise with inflation then trustees were free to adopt the lower CPI. About a quarter of schemes now use CPI – capped at 2.5%. Over the years the move to CPI has meant much lower increases in pension for the people affected.

The average salary-related company pension is less than £9,000 a year.

People who worked at the Bank of England are insulated from all these worries. Its pension scheme pays out at age 60 and raises the pension in payment each year in line with RPI with no cap. Employees pay in nothing but the Bank pays in 52% of their salary – more than double the normal contribution rate.

Despite their ‘gold-plated’ name, the average salary-related company pension is less than £9,000 a year. For many people their state pension – which is fully index-linked at least – is more.

Annuities

If you saved up in what is called a ‘money purchase’ or ‘defined contribution’ scheme and have used your pension pot to buy an annuity – an income for life – you might have chosen one which was linked to rising prices. There are two sorts. Some annuities are linked to the Retail Prices Index and there is no cap on them. These people are very fortunate indeed now as their annuity will rise with RPI inflation. Another index-linked annuity increases with Limited Price Indexation or LPI. The annual payment will rise with RPI but is limited by a cap of 5% or 2.5%. There is no discretion with an annuity to exceed the cap. Many people bought annuities without any index-linking and they will stay at the same fixed amount each year regardless.

Public sector

The rules are very different for public sector pensions. These are paid to people who worked in the civil service, for the NHS, as a police officer, a teacher, in the fire and rescue service, or for any other public employer. These pensions are not just gold-plated but solid gold. There is no cap on inflation proofing, though nowadays they rise in line with CPI not RPI. In April this year these pensions increased by 3.1% in line with the September 2021 CPI. With inflation this September predicted to be 10% that will mean a hefty rise in these payments from April 2023.

Inflation makes everyone poorer. Energy suppliers and almost all water firms offer help to people in financial difficulties. See turn2us.org.uk