The short answer to do Final Salary Pensions increase with inflation is yes, they do increase with inflation. Final Salary Pensions as with all defined benefit schemes, increase with inflation both as benefit entitlements before pensionable age and also when in payment.
Final Salary Pension schemes commit to making statutory increases to pension entitlements. This is of benefit to individuals who leave the Final Salary scheme but have built up preserved benefits which are retained are worked out in the usual way using a combination of accrual rate, pensionable earning, and years’ service. Benefits are not lost once they leave employment.
Thankfully, there is a statutory requirement on the scheme to revalue the Final Salary benefits to the scheme’s Normal Retirement Age (NRA), at least trying to ensure that the pension/salary keeps pace with inflation. Scheme rules will manage how this is done and which measure of inflation they use (CPI, RPI).
All of these statutory requirements add to the pension scheme liabilities, and therefore their costs of running the scheme. The costs of providing a defined benefit scheme weigh heavily on the balance sheet of the sponsoring employer.
The Pension Protection Fund released figures in 2016 that more than 80% of defined benefit schemes were in deficit and were collective £800 billion in the red.
This is in contrast to a defined contribution pension (e.g., personal pension pot or autoenrollment pension) where there is no embedded or automatic account made for inflation. In this case, your pension funds should be reviewed regularly to check they are not being eroded by the effects of inflation. This mainly refers to cash deposits that are earning less than the stated rate of inflation.
From an investment risk perspective, defined benefit schemes manage the risk on behalf of their members taking account of inflation as part of their remit. One of the downsides of transferring to a defined contribution scheme is that managing this risk would then lie with you and the assistance of your Financial Adviser (if you have one).
However, transferring your Final Salary Pension could be suitable if all the benefits of transferring such as death benefits, enhanced tax-free cash and flexible access outweighed the loss of guaranteed income for life which increases each year in line with inflation.
The tax-free lump sum available from a defined benefit scheme will usually be arrived at by using what is known as a commutation factor where part of the annual pension is given up in return for a lump sum. This will vary from scheme to scheme, but it is generally less generous than the sum that can be taken after a transfer has taken place. The maximum, in any event, is usually 25% of the value below the Lifetime Allowance (LTA).
Any Cash Equivalent Transfer Value (CETV) offered by your Final Salary Pension Scheme needs to represent a good deal, and this is best assessed by a Pension Transfer Specialist (PTS) who is regulated by the financial conduct authority. The PTS will look at all the relevant financial details, your personal circumstances and how much pension in retirement you and any financially dependent people you have, are likely to need for the long term.
This article looked at an introduction do Final Salary Pensions increase with inflation but there is a great deal more to consider than is covered here. The advice can only be given to an individual after a thorough assessment of all personal (and their partner’s) financial circumstances.
The next step is to have an informal exploratory chat with a qualified adviser to see if it is worthwhile proceeding to the formal process known as regulated advice.