Defined benefit pensions: increases before and after retirement

A defined benefit pension can increase while you are still building benefits, while it is deferred after leaving employment, and after payments begin. Those increases may follow different rules. A single phrase such as “inflation linked” does not explain all three stages.

To use the pension accurately in a retirement plan, identify the rules applying to each part and the date from which the quoted amount is measured.

Separate the stages

During active membership, a career-average pension may revalue benefits already earned while adding another year's accrual. After leaving, deferred benefits may increase under a different formula. Once the pension is paid, annual increases follow the rules for benefits in payment.

The LGPS guidance for former members provides an example of separate leaving-year adjustments, deferred increases and pension-payment increases. It concerns the LGPS in England and Wales and should not be treated as the rulebook for every defined benefit scheme.

Ask your own scheme for a breakdown rather than copying another scheme's inflation measure or limits.

Read the date attached to the amount

A statement may show the pension at leaving, at the latest annual update or projected to a future retirement date. These are different reference points.

Suppose a fictional deferred pension was £9,000 a year at leaving. With assumed increases of 3% and then 2%, it becomes £9,455.40. Adding another two years of increases to a statement that already includes them would overstate the benefit.

Record the valuation date and whether future increases are included. When comparing two quotations, bring them onto the same date and basis before interpreting the difference.

Different parts can have different limits

Older and newer service, guaranteed minimum pension elements and other scheme sections may receive different treatment. Ask for the relevant split, including any cap, floor or special condition.

As an invented example, imagine £6,000 of annual pension receives a 2% increase while £4,000 receives 4%. The increases are £120 and £160, making the new total £10,280. Applying 4% to the whole £10,000 would instead produce £10,400 and overstate the result by £120.

These percentages are hypothetical. Their purpose is to show why a blended pension cannot always be modelled using one headline increase.

Keep retirement-date adjustments separate

An early-payment reduction is a different adjustment from inflation revaluation. A later-payment increase can also have its own basis. Ask the scheme to show the sequence used in the quotation.

If a benefit has increased since the previous statement but is then reduced for early payment, the final figure might look unexpectedly similar to an older amount. That similarity does not show that revaluation was omitted.

Request the calculation rather than inferring the reason from the final number. Where different parts have different normal pension ages, the explanation may need more than one line.

Understand the first increase after payment begins

The first increase can depend on timing and may be proportionate rather than a full annual amount. Some benefits have age-related or other special conditions.

Ask when the first review occurs, which period it reflects and how it will appear on the pension payslip. The first payment after an increase date may contain only part of a month at the new rate.

Use the provider's confirmed annual figure and payroll explanation before updating a household budget. A single month's bank payment may also be affected by tax, making it a poor basis for inferring the gross annual increase.

Model spending power without assuming perfect protection

Even an increasing pension may not track every household cost. A cap can matter during high inflation, while the chosen index and review timing may differ from the prices you experience.

Ask an adviser to model the scheme's actual increase terms and a scenario in which important expenses rise faster. Keep tax and survivor benefits in the model as separate assumptions.

Bring the latest benefit statement, scheme booklet and recent quotation to the discussion. The aim is a pension figure that can be traced through its dates and rules, rather than a generic inflation-linked income entered into a chart.

See defined benefit pension advice, questions for a retirement adviser and cashflow modelling.