?With inflation in the U.K. at 10 percent, employers and retirement plan trustees are left grappling with the best way to administer their plans. The two types of retirement schemes—defined benefit plans and defined contribution plans—are affected in different ways.
Defined benefit (DB) plans are ones where pensioners know what benefit they’ll receive when they retire, while in a defined contribution (DC) scheme, the contribution is paid by the employee and employer based on each year of service and will build up like an investment pot over time.
“Inflation impacts people’s income. Pensioners who are drawing pension from a pension scheme will typically see increases each year on some or all of their pension to give some protection against inflation,” said Chris Brown, director at Burges Salmon LLP in Bristol, England. “Typically, in a defined benefit scheme, that increase will be capped. So where you’ve got inflation running very high like it is at the moment, [it] is higher than the actual increase that pensioners will be getting year on year. The consequence of this for people who are already drawing their DB pension is that the increases they’re getting year on year are not keeping pace with inflation. Their pension will be reducing in real terms.”
“Our team has calculated the potential impact, and we think overall U.K. DB pensioners could lose out on about 5.3 billion pounds [approximately $6.2 billion] of additional income a year due to inflation caps over the next two years,” said Dan Auton, senior consultant at XPS Pensions Group in London.
What Are the Pension Rules?
It’s important for pension trustees to understand what their particular pension increase rules are so they can understand what options are available. “My first takeaway point would be that trustees should understand what their rules say, how any cap works, and whether increases are by reference to RPI [retail prices index] or CPI [consumer prices index],” Brown said.
Most DB pension schemes will have rules that allow either the trustees or the trustee and the employer to decide to provide higher benefits than what is set out in the scheme’s rules.
A second takeaway point is for employers to think whether it’s possible or appropriate for them to provide discretionary increases, Brown added. “I would advise trustees to speak with the employer, even if there is no formal employer input required by the discretionary increase rule. Whether discretionary increases are appropriate will depend—among other factors—on the funding position of the scheme.”
With DC plans, inflation can affect members’ behavior and choice of investments.
Thinking About Early Retirement
An important issue for employees to consider is early retirement and how inflation will impact the payout from that choice. “If you retired fairly late 2022 versus early 2023, you could have a huge difference in the income that you’re expected to get,” Auton said.
Employers and trustees need to consider the impact of high inflation on early retirement, as well.
With pensions impacted by inflation, there might be more inquiries and complaints from plan members, and it’s important to be prepared for this. Schemes should have their own internal dispute resolution procedure (IDRP). Make sure an IDRP is on hand, up-to-date and responsive to any complaints that might arise, Brown said.
Katie Nadworny is a freelance writer in Istanbul.
