Are UK pensions indexed with inflation?

The basic State Pension

You can claim the basic State Pension if you are:

A man born before 6 April 1951
A Women born before 6 April 1953

To be eligible for the UK State Pension you must have paid or been credited with National Insurance Contributions.

The full State Pension is currently £8,750 per annum.

The UK State Pension increases each tax-year. The following three benchmarks are used to decide the increase – whichever of the following is highest will be the increase for that given tax year.

Earnings – the average percentage growth in wages (GB)
Prices – the percentage growth in prices in the UK as measured by Consumer Prices Index CPI
2.5%

Source: Gov.uk/state-pension

Defined Benefit

Often dubbed ‘gold plated’ pensions, defined benefit pensions pay out a continuous income for life. Assuming the continued security of the scheme, the pension will pay an income to a member for as long as they live.

Defined benefit pension schemes are designed to increase their payments to members each year using economic indicators such as RPI and CPI. Most private-sector pension schemes have a ‘cap’ on the pension increases at around 5% per annum.

Increases depend on;

The rules of your scheme
The period of service it relates to
whether part of your pension is in respect of contracting out of the State Earnings Related Pension Scheme. This is called a Guaranteed Minimum Pension (GMP)

Each tax year, your scheme must increase your pension (above your GMP)

any pension built up after 6 April 1997 is increased in line with the consumer prices index (CPI) or 5%, whichever is lower
any pension built up after 6 April 2005 is increased in line with the consumer prices index (CPI) or 2.5%, whichever is lower.

However, your scheme does not have to increase any part of your income built up from savings made before 6 April 1997, except for the GMP.

These are the minimum increases that your scheme has to pay, by law. Your scheme may increase your pension above these levels. These additional increases may be set out in the scheme rules or paid on a discretionary basis. Where it is the latter, the scheme has no obligation to continue to apply the increases.

Source: The Pensions Advisory Service

Defined Contribution

A defined contribution (DC) pension is distinctly different from a defined benefit pension. With a DC scheme, the employer and employee build a pension pot which is invested within a scheme. The pot is designed to be drawn down from in retirement. DC schemes can run out of money, meaning members cannot depend on them indefinitely in retirement. However, if a DC scheme is managed to the point at which the drawdown is equal to the growth each year the pot could, in theory, outlive the member.

For example, if a member builds a pot to the size of £1,000,000 which grows at 5% each year the member could draw down £50,000 per year in retirement and the pot would not reduce in size.

The pot’s longevity depends on
1. the underlying investment performance
2. The amount which is drawn down

To learn more about your UK pension click here.

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