Annual increases in rates of pensions
How does this policy make a difference?
- Reducing the level at which the cap is set will ease the financial burden on defined benefit schemes and balance the cost that will be imposed by the Pension Protection Fund.
- It will ease the difficulty that defined benefit schemes have in trying to find assets that are a suitable “fit” for LPI-linked pensions.
- For members of defined contribution arrangements, removing completely the requirement to index pensions in payment will mean greater choice in the type of annuity they will be able to purchase. By opting for a flat-rate annuity they will benefit through a higher starting pension than would otherwise be the case.
Limited Price Indexation
The requirement to index pensions in payment is currently set at the annual percentage increase in the Retail Prices Index capped at 5%. For all types of occupational schemes, this applies to the whole of the pension in payment. For Appropriate Personal Pensions (the term applied to personal pensions used to contract out), it applies only to that part of the pension derived from the contracted-out rights. These requirements are known as Limited Price Indexation and apply to all pensions in payment deriving from rights built up on or after 6th April 1997.
The changes will mean that increases in defined benefit occupational pensions derived from benefits built up on or after the date the changes come into force must be increased by the annual percentage increase in the Retail Prices Index capped at 2½%. The indexation requirements for defined contribution occupational pensions and personal pensions will be removed altogether. People will however still be able to opt for an index-linked pension if that is what they wish.
Pensions that are in payment before these changes come into force will not be affected.
The changes to defined contribution arrangements introduced in the Pensions Act 2004 apply only to pensions derived from benefits built up on or after 6 April 1997. Different indexation requirements apply to benefits built up before then and these will be removed in due course. The changes needed to do this will be introduced so that they come into force at the same time as those being made in the Pensions Act.
- Find out more about the Government's pension reform plans.