Aled Edwards, Partner at Quantum Advisory discusses the impact on pension scheme members taking early retirement in times of high inflation.
The unusually high level of inflation being experienced in the UK is forcing trustees of defined benefit schemes to review their schemes and consider the impact of this on members who are considering taking early retirement imminently.
For those who missed it, the annual rate of CPI inflation was 10.1% for the 12 months to September 2022 – its highest level since the 1980s.
The impact on members taking early retirement
A member that chooses to take early retirement before the end of 2022 will receive an annual pension increase next year on part of their pension which is likely to be capped at 5%. Any increase will be applied proportionally to reflect the fact the member hasn’t been retired for a full 12 months.
Conversely, if they wait until January 2023 before retiring, they would benefit from the full CPI inflation rate of 10.1%. This is because the commonly used 5% per annum cap on revaluation for deferred members applies cumulatively over the whole period between ceasing active membership and retiring, rather than being applied on a year-by-year basis as is the case for increases after retiring. The overall value of a 2022 early retirement pension could therefore provide materially lower value for a member than if they delayed their retirement until 2023.
The preservation requirement in pensions legislation states that trustees need to be reasonably satisfied that the value of the early retirement pension will be no less than the value of the deferred pension. Unless benefits are adjusted, trustees run a risk of paying pensions which do not meet this requirement.
What can trustees do
- Trustees could take the view that no action is necessary, because a member choosing to take early retirement is doing so completely voluntary. The supporting argument here being that members taking early retirement are influenced by multiple factors, some of which are outside the knowledge and control of the scheme and trustees.
- If trustees provide any blanket consent for members to early retire then it may be appropriate to withdraw this in the best interests of the members; with the cost-of-living crisis we’re all experiencing currently this may, indeed, be appropriate!
- Most members are unlikely to fully understand the potential consequences of delaying their early retirement, so trustees should also consider [, as a minimum,] introducing additional wording within all early retirement quotations that clearly explains the situation and recommends that members consider very carefully whether early retirement is in their best interest or whether delaying would be more beneficial.
- Trustees could also allow for the current spike in short-term inflation by adjusting the calculation of early retirement pensions through a full review of the early retirement factors or through the application of a temporary adjustment.
- For smaller schemes where the volume of early retirements is very low, trustees may choose not to incur adviser fees unless absolutely necessary. They may therefore apply any adjustments on an ad-hoc basis if such a case proceeds through to completion.
Next steps
High inflation and the cost-of-living crisis means that now, more than ever, every penny counts. To ensure that members of defined benefit schemes that are considered early retirement don’t inadvertently lose out trustees should review their early retirement rules, the factors they use on early retirement and their member communications. Only then can they take the appropriate steps to ensure that they continue to provide fairness and value for all members. Doing nothing is not really an option!