Occupational pension increases

Types of pensions in the UK

The two main types of pension schemes in the UK are:

• Defined benefit schemes pay a guaranteed pension based on factors like salary and length of service. An employer, or another sponsor, guarantees the pension payments. The pension usually pays income for life and may include a lump sum.
• Defined contribution schemes provide a pot of money for retirement, not a guaranteed pension. The value can rise or fall depending on factors like investment returns and contributions made.

There are statutory requirements for increasing pensions from defined benefit schemes. These do not apply to defined contribution schemes which do not guarantee the pension they provide.

Increases to pensions from defined benefit schemes

The statutory requirement to increase defined benefit pensions depends on whether the pension is in payment. Indexation applies to pensions in payment, while revaluation applies to deferred pensions. Deferred pensions are those where someone is no longer accruing (building up) their pension but has not yet drawn a payment. For example, where they have left employment but not yet retired.

Indexation

Schemes must increase pensions in payment annually if the pension rights were accrued after April 1997. They index (increase) these pensions in line with prices. There is a cap of 5% on annual increases for pension rights earned between April 1997 and April 2005. For rights earned after April 2005, the cap is 2.5%.

Schemes do not need to index pension rights accrued before April 1997. While there have been calls for this to change, successive governments have committed to a broad principle of not imposing requirements retrospectively. 

Schemes may offer more generous indexation than legislation requires.

Revaluation

Schemes must annually revalue deferred pension rights accrued since 1 January 1986 in line with prices. A cap of 5% applies for service to 5 April 2009 and at 2.5% for service after this.

Guaranteed Minimum Pensions (GMP)

Separate requirements apply to Guaranteed Minimum Pensions (GMPs). GMPs are a part of pension schemes which “contracted out” between 1978 and 1997.

The Library research briefing Guaranteed Minimum Pension (GMP) increases has further details.

Measures of inflation

The primary legislation, the Pensions Scheme Act 1993, does not specify which measure of inflation should be used for minimum indexation and revaluation. Instead, it refers to the “percentage increase in the general level of prices in Great Britain.” Since 2012 the government has used the Consumer Price Index (CPI) to set the statutory minimum increase each year.

Prior to this, the government used the Retail Price Index (RPI). Many pension schemes still use RPI as it is a feature of their scheme rules. RPI has not been a national statistic since 2013 and reforms are planned to take place to address the shortcomings of the measure in 2030.