How much will my pension be?
You know the answer to this question is not straightforward!
It very much depends on the type of scheme, retirement age, membership status and options chosen.
In this section we will look at defined benefit schemes.
Active Member status
From other modules you have studied you know that for active members of defined benefit schemes the amount of pension at normal retirement age depends on how long they have been a member of the scheme, the accrual rate and the salary definition.
As a basic example, if a scheme has 60ths accrual, the member has 30 years pensionable service and the final salary is £25,000, the pension would be:
However, if the member with the same details was retiring before normal retirement age, an early retirement factor would be applied.
This reduction is to take account of the fact that the member will be receiving the pension for a longer period of time. Some early retirement factors are prescribed in the scheme rules.
As an example, if a member was retiring 5 years early, the factor may reduce the pension by 20% so the member would receive £10,000 per annum.
Early retirement may be possible without a reduction applying, such as in redundancy or ill-health cases.
As a result of equalisation there may be different tranches of benefits for which separate calculations need to be made. The scheme rules should be checked for further details regarding this.
Pensionable Service can also be discontinuous owing to periods of non-pensionable absence such as extended maternity leave, strike action and sabbatical.
If a member did not elect to make up missed contributions on returning to work, the pensionable service may be less than the dates suggest. The scheme rules may also allow for prospective pensionable service to Normal Retirement Age to be included, for example in ill-health cases.
Periods of part-time employment will be reflected by pro-rated pensionable service or pro-rated salary according to the scheme rules.
If a scheme was contracted-out, the pension must be at least equal to the GMP at the GMP due date. If it is not, the member may not be able to retire early.
Deferred Member status
If the member has already left a defined benefit scheme, the accrued pension at date of leaving will already have been calculated at that time.
Some of the pension may increase between date of leaving and retirement, and some of it may not. Legislation regarding this has changed over the years so the pension has to be split between different tranches of service and the relevant rate for the periods of those tranches applied.
The most common tranches are:
For leavers after 1 January 1991 the statutory revaluation applies to the whole of the pension accrued in excess of the GMP for each complete year between date of leaving and the retirement date. The revaluation amount is the increase in the Consumer Prices Index up to a maximum of 5% for benefits accrued before 6 April 2009 and; a maximum of 2.5% for benefits accrued after that date.
For leavers before 1 January 1991 the position is slightly different.
Members who left between 1 January 1986 and 31 December 1990 – the revaluation applies to excess benefits accrued after 1 January 1985 only; and members who left before 1 January 1986, don’t receive any revaluation increase on their excess benefits.
If the pension includes a GMP in respect of contracted-out benefits, different revaluation rates apply depending on when the member left the scheme and the type of revaluation adopted by the scheme.
If a deferred member is retiring before normal retirement age, an early retirement factor will be applied to reflect the longer period over which the pension will be paid.
If a scheme was contracted-out, the pension must be at least equal to the GMP at the GMP due date. If it is not, the member may not be able to retire early.
Preserved benefits from Public Service schemes are increased in line with increases in price inflation. This follows the provisions of the Pensions (Increase) Act 1971.
Bridging Pension
Some schemes allow bridging pensions when a member retires before age 65 or 60.
Bridging pensions may also be known as "temporary pension” or "state offset” and are designed to smooth income and alleviate possible financial hardship before the state pension becomes payable.
Originally, a bridging pension had to cease at 65 by law but with the legislative changes to State Pension Age, the trustees may have amended the scheme rules to take into account the new state pension ages, in which case, the pension may be paid for longer.
When planning retirement finances it is important for the member to understand that their income from the scheme will reduce at a certain time and be replaced from a different scheme. The member needs to be sure to understand when this reduction will take place, the impact it will have on their income and if there will then be any gap before they actually become entitled to receive the state pension.
The State Pension and the Bridging Pension may not directly correspond – the bridging pension from the scheme is only broadly similar to the basic State pension.
Late Retirement
A member may wish to continue working to maintain their lifestyle, even on a part time basis. When members need to make such decisions, the factors they need to consider include their health and for how long they think they will live. Continuing to work for a few more years may be financially beneficial to help with the fact that, in general, we are living longer.
For some people who started retirement saving later in life, it is a financial necessity to continue working. There is no longer a Default Retirement Age, and attempting to compel a member to retire at a scheme’s NRA is no longer lawful.
The scheme rules will either allow:
1. The member to continue contributing to the scheme and accrue further benefits (up to age 75 for most schemes);
or
2. Membership must cease whereupon the benefits are calculated at normal retirement age but can remain in the scheme.
When the member eventually retires, the pension is increased by a late retirement factor so the member receives a higher amount to reflect the later payment. The member will need to investigate if the increase applied would provide a higher amount than if they received the pension and invested it.
If a member is allowed a choice, they must also consider the death benefits payable. Life assurance may be provided under a separate scheme so the member will need to check if/how late retirement impacts on these benefits.
