Older employees who are nearing retirement age on final salary deals could be in for a shock as surging living costs outpace rises in their incomes, experts at XPS Pensions Group have warned.
They said that while many private sector Defined Benefit pensions (DB) increase in line with inflation, often this is subject to an annual cap, commonly set at 5%, however with inflation rising above the caps - currently at 7% - pensions could soon lag behind as the figure is expected to climb higher in the coming months.
Steve Leake, a partner at XPS Pensions Group, explained: "Private sector DB pension benefits often increase in line with inflation but a lot of increases are capped at 5%.”
He continued: "If inflation were to reach 10% this year - which isn't out of the question - our modelling suggests that UK pensioners would collectively lose £1.7 billion in pension benefits in real terms, which works out to about £400 a year for the average retiree."
XPS Pensions Group estimates that a pensioner could end up losing around £7,000 over their future lifetime, although on the other hand the caps could mean UK DB schemes are protected from an additional £30 billion of liabilities, according to the calculations.
Some DB schemes may come under pressure from members to award discretionary increases in excess of the rules, XPS suggested. Its DB:UK funding watch monitors the deficit and funding level of UK DB pension schemes.
Sir Steve Webb, a former pensions minister who is now a partner at Lane Clark & Peacock (LCP), said: "Many people will not be aware that there is a limit to how much inflation protection their company pension scheme will provide.
"The exact limit depends on the individual scheme, but many workers will find that their next pension increase falls significantly short of the rising cost of living.
"This suggests that the squeeze on living standards which many are facing will run well into 2023 and will not be a temporary phenomenon."
Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said: "The cap on inflationary pension increases is going to come as a nasty surprise to those in defined benefit schemes that are subject to a cap.
"It's such a long time since we saw inflation at this level that a below-inflation increase will come as a shock to the system."
Ms Coles continued: "Last time we were in this position, pension trustees decided to use their discretion and pay over the cap anyway, because at the time so many were running a funding surplus.
"Now, most are in deficit, so it's highly unlikely they will do this. They're far more likely to see this as an opportunity to try to improve their funding position slightly.
"But in the grand scheme of things, this is far less of a problem than the one facing people with defined contribution (DC) schemes who bought a level annuity.
"They will be looking on in envy at the DB schemes where increases are capped at 5%.
"They have no inflation built into their pension payments at all, so some of them will really be struggling with the runaway rise in the price of essentials."
To keep up to date with the latest pensions news, join our Money Saving Scotland Facebook group here, follow Record Money on Twitter here, or subscribe to our twice weekly newsletter here.
