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Index Linking: How Does That Work?

You are often told that you have an ‘index-linked’ pension and, following the recent announcement of the pension adjustment for April 2021, now seems a good time us to explain what index-linking means and how it works.

Basically, your pension is going to keep pace with inflation – but what sort of inflation measure is used and who decides? There are three different inflation measures that are commonly seen quoted in newspapers and financial articles in magazines:

The Retail Price Index (RPI);
The Consumer Price Index including owner occupiers’ housing costs (CPIH); and
The Consumer Price Index (CPI).

In the mid-2000s, the inflation measure used for the adjustment of pensions was changed from RPI to the usually less generous CPI rate, but the introduction of CPIH (which has been running at a slightly higher rate than CPI) has caused a little confusion. Let us reiterate that it is CPI that is the UK’s official measure of inflation when looking at the adjustment of pensions.

Armed Forces pensions, once awarded, are adjusted in April each year by CPI and CPI is set by the Bank of England’s Monetary Policy Committee. The CPI rate used is the CPI headline rate for the September prior to the April adjustment the following year. This rate is formally announced in October each year, and this October it was announced that the April 2021 adjustment will be 0.5%. It is these annual CPI increases that constitute index-linking – your scheme refers to them as Pension Increases or PIs.

This increase comes into force not on 1 April each year but on the first Monday after the beginning of the new tax year. So, for April 2020, the increase comes into force on 12th April.

The first PI is paid on a sliding scale depending upon when in the year you leave. The year runs from 1 April – 31 March each year and the earlier you leave in the period 1 April – 31 March the more of the increase you will receive in the following April. Put very simply, those leaving in the first few weeks of April will get the full PI the following April, those leaving in October will receive about half of the PI the following April and those who leave in the last couple of weeks of March will get no increase in the following April. The full increase is paid in subsequent years. This applies whether the pension is to be paid immediately or not. The proportion of the first increase you receive can make a big difference to your cumulative pension income if CPI is high in the year you retire and, whilst most of you cannot do anything about your discharge date, for those of you who can, it is worth remembering that the date you leave matters.

If you are leaving with an AFPS 75 Immediate Pension (IP) or AFPS 05/15 Early Departure Payment (EDP) benefits, and are not yet aged 55, the PIs are stored for you and become payable at age 55. Many of you will take Resettlement Commutation, which means that you have chosen to receive a reduced pension until age 55 in exchange for a second lump sum on discharge. When the PI is applied, it will be applied to your original pension award, not the reduced amount. You do not have to apply for this to happen but Veterans UK may write to IP recipients to ask what other occupational pensions have been earned or might be in payment. They do this to check whether the HMRC Life Time Allowance will be breached (which, for the majority of us, it will not). Once satisfied, they will apply the PIs for the period since you left the Armed Forces. For those of you who will be receiving EDP benefits a gentle reminder – even though your EDP benefits are in payment, you will need to claim your pension when the time comes. That will NOT happen automatically!

If you leave with an IP and then take up a further military post, your pension will be subject to the AFPS 75 abatement rules. These rules could see your pension stopped, wholly or in part, for the duration of this further employment. If you are still in this further employment when you reach age 55, any abatement continues but you are entitled to receive the PIs which have built up since you left the Regulars and the PI in each April thereafter.

If you are leaving with a preserved/deferred pension, PIs will be added prior to the pension coming into payment to take account of all the PIs that have occurred since you left. Once your pension is in payment, PIs will be applied each April thereafter.

Time for a few examples, I think. All are looking at pension awards (immediate or preserved) made when the member left service, where the member has received PIs in 2020:

  • Flight Sergeant Jenkins left with an AFPS 75 IP in early April 2005 at age 40. His pre-commutation pension was £10,360. On his 55th birthday in early April 2020 his pension will rise to £15,008.53 and, on 12th April 2021, it will rise by 0.5% to £15,083.57.
  • Lance Corporal Jones left in early July 1988 with a preserved AFPS 75 pension of £1,208.90 in respect of his 10 years Reckonable Service. He claimed his preserved pension at age 60 in early July 2020 and his original award of £1,208.90 had become £2,991.06 (with a lump sum of three times that amount). On 12th April 2021, this £2,991.06 will rise by 0.5% to £3,006.02.
  • Chief Petty Officer Morrison transferred to AFPS 05 and left just before his 55th birthday in mid-December 2010 with Early Departure Payment (EDP) benefits in payment and a preserved pension payable at age 65. His preserved pension was £15,000. His EDP would have started to receive annual PIs from his 55th birthday. On claiming his AFPS 05 preserved pension in mid-December 2020 he would find that the original award of £15,000 had risen to £18,346.50 (with a lump sum for three times that amount). On 12th April 2021, this £18,346.50 will rise by 0.5% to £18,438.23.

Whether your pension is an AFPS 75 IP or a preserved/deferred award from any of the Armed Forces schemes, you might like to keep an eye on it for financial planning purposes. Members are entitled to one free forecast per year. For those with preserved/deferred pensions, forecasts are obtained by submitting an AFPS Form 14 to Veterans UK. For those with an IP in payment, forecasts are obtained by contacting Equiniti Paymaster on 0845 121 2514 or email veteransukpension@equiniti.com – you will need your Service Number and National Insurance number for identification purposes.

PIs are applied early in only three circumstances:

  1. If you are discharged with an invaliding pension, PI are payable from the outset. This means there is no big increase at age 55 because, unlike those who left with an IP, you will have been receiving PIs from the outset.
  2. If you are unable to work full time due to mental or physical disability which is deemed to continue until your preserved/deferred pension age you can claim your pension early, with PIs added. If you are in receipt of an IP but not yet 55 you can apply for PIs to be paid early if you are unable to work full time due to permanent ill health. Applications are made on an AFPS Form 8 on receipt of which Veterans UK will seek your permission to approach your GP for medical information in support of your claim.
  3. If you die, PIs are applied to your family’s benefits, irrespective of your age or theirs.

If you are a member of the Forces Pension Society and would like to know more about PIs or any other pension issue, email us on pensionenquiries@forpen.co.uk.

If you are not a member but would like to learn more about us click here

Author: Mary Petley, 18 November 2020 for December Pathfinder Magazine

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