I have been offered a ‘PIE’ – a Pension Increase Exchange. Any general comments or advice would be welcome.
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PIE offer: Employers might offer you a higher pension at the start of retirement if you give up some inflation-protected increases later – but are these deals worth it?
Steve Webb replies: When you are a retired member of a final salary pension scheme, the law requires your scheme to increase your pension each year to take account of inflation, subject to various caps and other restrictions.
For example, they only have to increase the part of your pension you built since 1997. Similarly, there is a cap on the annual increases that they have to pay when inflation is high.
However, in practice, many schemes offer more generous inflation protection than the minimum required by law. For example, they may link the whole of your pension to inflation and not just the bit that you earned since 1997.
When a scheme offers you a PIE or a ‘Pension Increase Exchange’, what they are doing is giving you the chance to give up those additional ‘non statutory’ rights – just the ones it offered you voluntarily under its terms and conditions when you signed up, not any of the protection required by law.
What is a final salary pension
Generous gold-plated defined benefit – or final salary – pensions provide a guaranteed income from retirement until you die.
Most private sector employers have now replaced them with stingier and riskier defined contribution pensions.
These take contributions from both employers and employees and invest them to provide a pot of money at retirement, but workers bear all the investment risk. This is Money
In return for this they will offer you a higher starting pension. As a result, you will get more money now and in the earlier part of your retirement but you will get a lower pension later in retirement because you have given up some of your inflation protection.
From the scheme’s point of view, this can be an attractive deal because it reduces the uncertainty to them of how much they will have to pay you in decades to come.
With a generous indexation arrangement, the scheme has to forecast what inflation will be in coming decades and also has to forecast how long you and other scheme members will live, as this affects how long they have to go on offering this generous inflation-linked pension.
If they can get you to accept a higher pension now, but to give up some of your inflation protection, then they are exposed to less inflation risk.
How might your pension be affected by a PIE deal? Find out more about how they work in practice below.
What should you consider if offered a ‘PIE’?
From your point of view, the first thing to do is to take up any free advice or guidance that they have offered you.
Although the firm may be paying for the advice, you should find that an adviser can impartially talk you through your options and the pros and cons of each.
An advantage of taking a higher starting pension is that this will give you more money earlier in your retirement.
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If you think that you might, for example, be more likely to travel while you are younger, then a bit of extra cash now might be quite attractive, even though this means you will have a lower pension later in retirement.
Conversely, if you end up needing expensive care later in retirement you might wish you had stuck with a pension that went on rising generously through your retirement.
Another issue to think about is how long you are likely to live. The offer that the company has given you will in part reflect average life expectancies for scheme members.
If you are in poor health then you might welcome the chance to bring forward some extra pension to enjoy now.
On the other hand, if you come from a family where previous generations were long-lived and if you are in robust health then you might think that decades of generous inflation protection is a better option than a higher starting pension but decades of poorer increases.
One other thing to think about is taxation. A higher starting pension now could possibly push you into a higher tax bracket – for example, move you between the 20 per cent and 40 per cent bands – and this would reduce the value to you of any uplift.
This could be a particular issue if you are still in some form of paid work and the enhanced company pension would be in addition to wages.
Accepting this kind of deal is also likely to affect the payouts a spouse would get if you died before them, so if you are married or in a civil partnership it’s a good idea to consult your partner on their wishes.
STEVE WEBB ANSWERS YOUR PENSION QUESTIONS
Ultimately, this will be very much an individual choice. Company pension schemes generally make these offers because it improves the funding position of the scheme overall as well as reducing their risk, so they don’t do it unless they think they could come out ahead.
However, it can be a ‘win win’ situation if you think the offer might be to your individual advantage too.
So you might decide simply to leave things as they are, and you have every right to decline the offer.
But if you strongly value higher income earlier in retirement and/or you don’t expect to be drawing a pension for all that long, then a Pension Increase Exchange might be worth thinking about.
How might a Pension Increase Exchange work in practice?
Suppose you are due to get a pension of £100 per week when you retire at 65. You worked for an employer for 10 years between 1992 and 2002.
Under the rules of your pension scheme, your full pension goes up each year in line with inflation, which we assume is 2 per cent per year.
Without the PIE, your pension starts at £100, is £102 in year two, £104.04 in year three and so on.
However, this is a relatively generous scheme. The firm is only obliged by law to pay you inflation increases for the years you worked since 1997, but it agreed to do so for the years before 1997 as well under the terms and conditions of its scheme when you signed up.
If you now agree to a PIE, it has to pay you 2 per cent increases for half of your pension, but doesn’t have to pay any inflation increases for the other half. This means the legal minimum inflation increase is 1 per cent.
Under a PIE, the scheme could offer you a higher starting pension – say £110 per week – but then only pay you 1 per cent per year in inflation increases.
As the chart below shows, you would have a higher pension in the earlier part of your retirement but a lower pension later on. In this example you would be getting more each week until you are aged around 75, and less each week thereafter.
The chart only goes up to age 89, but if you lived to 100 you would by then be getting significantly less if you agreed to a PIE.
ASK STEVE WEBB A PENSION QUESTION
Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.
He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.
Since leaving the Department of Work and Pensions after the May 2015 election, Steve has joined pension firm Royal London as director of policy.
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If Steve is unable to answer your question, you can also contact The Pensions Advisory Service, a Government-backed organisation which gives free help to the public. TPAS can be found here and its number is 0800 011 3797.
Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.
If you have a question about state pension top-ups, Steve has written a guide which you can find here.