Occupational pension increases

Types of pensions in the UK

There are two main types of pension schemes in the UK. These are:

• Defined benefit schemes pay a promised pension which is based on factors such as salary and length of service. A sponsor, which is usually an employer, guarantees the promised benefits are paid. The pension provides an income for life and may also include a retirement lump sum.
• Defined contribution schemes do not provide a guaranteed pension and instead provide a pot of money which can be used in retirement. The value of the pension pot can increase or decrease depending on factors, including investment returns and contributions made.

There are statutory requirements about how pensions from defined benefit schemes should be increased. These do not apply to defined contribution schemes where the pension they provide is not guaranteed.

Increases to pensions from defined benefit schemes

The statutory requirement to increase defined benefit pensions differs depending on whether or not the pension is in payment. “Indexation” applies to pensions in payment whereas “revaluation” applies to deferred pensions – those no longer being accrued (built up) but not yet being drawn (for example where someone has left employment but not yet retired):

Indexation

Pensions in payment must be increased annually in line with prices for pension rights accrued since April 1997. This indexation is capped at 5% for pension rights accrued between April 1997 and April 2005, and at 2.5% for rights accrued since then.

There is no requirement for schemes to provide indexation of pension rights accrued before April 1997. While there have been calls for this to change, the Government has committed to its broad principle of not imposing requirements retrospectively. 

Schemes may offer more generous indexation than required through legislation.

Revaluation

Deferred pension rights accrued since 1 January 1986 must be revalued in line with prices. This is capped at 5% 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), which are a feature of many pension schemes that contracted out of part of the state pension between 1978 and 1997.

Further detail about GMP increases is available in the Library research briefing Guaranteed Minimum Pension (GMP) increases.

Measures of inflation

The primary legislation 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) as the measure of prices used for setting the statutory minimum increase each year.

Prior to this, the Government used the Retail Price Index (RPI), which is still used by many pension schemes as it is a feature of those schemes’ rules. RPI has not been a national statistic since 2013 and reforms are planned to take place to address shortcomings of the measure in 2030.