I have two final salary pensions neither of which give me any annual uplift in respect of service (and thus paying into the schemes) before 1988.
I left the companies in 1984 and 1997. Why is this? What is the significance of 1988?
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Retirement finances: Why don’t my pensions built up before 1988 rise with inflation?
Steve Webb replies: When company pension schemes were first set up, this was offered freely as an extra benefit (and sometimes only to certain employees).
Because they were freely set up by firms as an optional extra, there were very few rules and regulations around the benefits which they had to provide.
In particular, there were no legal requirements to pay annual increases for inflation on pensions in payment.
Over time there have been two main changes affecting the rules on this.
The first came in 1978 when the ‘state earnings-related pension scheme’ was introduced.
SERPS offered a salary-related retirement pension to all workers via the state pension system.
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But there was a risk that for those in company pensions already this would amount to ‘double provision’ – a worker would be paying in to his or her company pension as well as paying National Insurance contributions towards an earnings-related pension from the state.
To avoid this double provision, the idea of ‘contracting out’ was introduced.
Final salary pension schemes were allowed to ‘contract out’ of SERPS, with employers and employees paying a reduced (‘contracted out’) rate of NICs.
But in return for this, the company pension scheme had to promise to provide a pension at retirement at least as good as the SERPS pension which a non contracted out worker would get.
This was known as a ‘Guaranteed Minimum Pension’ or GMP.
Initially, there was no requirement for these GMPs in payment to be increased each year in line with inflation.
But in 1988 the rules changed and GMPs built up from 1988 onwards have to be increased in line with inflation up to a maximum of 3 per cent.
This is why 1988 is a significant year.
During the 1990s, the funding of company pension funds generally improved (to the extent that some employers were taking ‘contribution holidays’ to make sure their schemes were not over-funded).
Against this backdrop, the 1995 Pensions Act introduced new duties on company pension schemes in respect of pensions in payment.
With regard to service from 1997 onwards, all pensions in payment have to be increased each year for inflation.
For service from 1997 to 2005, inflation has to be covered up to a limit of 5 per cent and for service from 2005 onwards, the requirement is to meet inflation up to 2.5 per cent.
This requirement applies to all salary-related pension schemes, even those which were not contracted out.
It is worth saying that all of this description is about the legal minimum level of inflation protection which has to be paid.
Some contracted out schemes already offered some inflation protection before the 1988 changes, while some schemes chose to apply the 1997 rule change to service before 1997 on a voluntary basis.
Finally, in the event that your employer or former employer should go out of business and your pension ends up in the Pension Protection Fund, a different set of rules applies.
These broadly mirror the provisions of the 1995 Pensions Act and provide annual inflation increases only in respect of service since 1997.
The PPF uses inflation as measured by the Consumer Prices Index (CPI), even though many pension scheme rules may provide for inflation increases based around the (generally higher) Retail Prices Index (RPI) measure.
