Public service pension schemes are now responsible for ensuring contributions are increased in line with inflation. The move will see the government meet its longstanding commitment that guaranteed minimum pensions (GMPs) continue to increase annually.
Although the decision primarily affects public service pension schemes, a few small private sector schemes will also be affected. This includes those whose rules mirror the public sector provisions because they were originally sponsored by a nationalised body such as Royal Mail or BT.
Past governments gave unequivocal commitments to public servants that their GMPs would continue to increase in line with price inflation each year. Such rises used to be met through combining increases in the state pension with additional rises made through the public service scheme.
Until 5 April 2016, a useful arrangement existed to meet the government’s GMP commitments to those whose pensions were contracted out through their membership of schemes in the private sector. Essentially, this arrangement saw the additional earnings-related part of the state pension increased in line with inflation, before the contracting out deduction was made.
The deduction was equivalent to the member's GMP. The contracted out scheme was only required to increase the post-1988 GMP, in line with prices up to a maximum of 3 per cent annually. The rest of the inflationary increase was effectively provided by the state – provided the GMP was less than the additional state pension and the individual was entitled to state pension increases. This arrangement shared the burden of the annual inflationary increase between the state and the public pension schemes.
This arrangement came to an abrupt end in 2016, when the single state pension was introduced. Individuals reaching state pension age after 5 April 2016 don't have an additional state pension. This meant that such people could have lost full inflation protection of their GMPs, which would amount to a breach of the government’s commitments.
To meet its commitment to fully uprated GMPs in line with price inflation, the government had to do something. An interim solution involved issuing orders that made the schemes responsible for full price indexation on the whole of the member's pension, including the GMP. This temporary solution initially applied to those reaching state pension age before 6 April 2018, before it was extended to 5 April 2021.
To arrive at a permanent solution by April 2021, the government conducted a consultation in 2020. In light of this, it announced that from 5 April 2021 the full indexation of the GMPs in public service pension schemes would become permanent. It has ruled out alternatives such as converting the GMPs into other benefits.
This provides clarity for pension schemes going forward, while also providing certainty to their members. While the changes primarily affect public sector pensions and former state companies, other schemes affected include those that provide comparable schemes to comply with Fair Deal, where a public service was outsourced. Some members of such schemes will also benefit from the decision to protect the increases on GMPs, although the employer will bear any additional costs.
This government’s decision will not affect members of private sector schemes that do not mirror the public sector provisions. Some members with GMPs may be worse off in terms of their pension increases. However, the state pension reforms were complex and such losses could be offset in other ways. For example, it may be possible for them to earn additional state pensions to replace the deduction they had from having had their pension contracted out. After five years of uncertainty, during which time interim solutions applied, at least the industry now has clarity and can plan better for the future.
Kate Payne is a partner and Max Ballad a legal director at Arc Pensions Law