Baxter Fensham Limited Financial Planners - Financial Planners, Wealth Managers, Tax Planners

Is your pension at risk? Modern day employment trends mean most of you who have not yet retired and drawn their pension, will have moved jobs on at least one occasion. (The impact of the current economic climate is likely to have this effect on many more). On life’s journey, you may well have had the benefit of being a member of a Final Salary pension scheme, (this being a scheme where your ultimate benefits are determined by your pension-able salary and length of service).

If this applies to you and you no longer work for the employer who provided the scheme, the rules applying to the benefits you have accrued are not the same as those applying to active members, (I.E. those still working for the employer).

You will have what are known as ‘preserved benefits’. The rules applying to the inflation proofing, (revaluation) of these benefits have changed several times over the years and I shall not go into detail here. The big issue of the day affects those who have accrued benefits from service since 1986. Whereas those benefits have until recently, been inflation proofed at the rate of the Retail Prices Index, (RPI), to a maximum of 5%, this will no longer be the case

Michael O’Brien, the minister for pensions reform, announced, (quietly), in the Spring of 2008 the inflation-proofing cap will reduce to 2.5%. At the time of writing, RPI is currently of the order of 0.9%, (though it has recently been as high as 5%). 

Inflation CPI down to 2.3%, RPI down to -1.2%

The above graph is an excerpt from the report on the National Statistics Website on May 21st 2009

Interestingly, as you can see in the table above, the Governments preferred measure of inflation, the Consumer Price Index (CPI) at the time or writing has just fallen to 2.3%. There are a number of differences between the two, though the key ones we all relate to are, CPI does not take into account mortgage interest payments and house price movement.

If we were to assume a long term average for RPI of say 2.5%, you would logically think your benefits would maintain their buying power against RPI, even id they do not keep up with the growth in earnings. Unfortunately this is not the case. To demonstrate let me give an example;

Let us assume at the date of leaving employment you had built a pension entitlement of £30,000 p/y. The RPI over the following 5 yrs ‘averages’ 2.5%.

The above example table demonstrates a difference in a ‘reduced increase’ in benefits of approximately 26% after just 5 years under the new rules, yet the ‘average’ RPI over the period was 2.5%.

The differences noted above may not sound a great deal, yet a technical manager from one of the leading life offices has calculated the impact on an individual who left their company in their mid 40’s, could see a reduction in their ‘benefits’ at retirement of 25%! Please note that is a reduction in benefits, not a reduction in the ‘increase’ in benefits.

It is also worth noting, had your benefits increased in line with national average earnings, those benefits would have been significantly greater still. You can work this out for yourself on www.statistics.gov.uk

In short, if you are placing a significant reliance upon your future financial independence upon preserved pension rights, now may be a good time to seek advice as to the precise impact this new ruling will have on you. Good advice will enable you and to consider objectively any action you may need to take to ensure your financial security stays on track. This has never been more important, as we are in a time when a number of large companies have failed, some with under funded pension schemes.