“The increase in my pension this year is not the same as the RPI figure, why?” and “How do I know if the pension scheme has calculated my pension increase correctly?”  

These are typical of many questions received from scheme members.  The answer should be straightforward, but, like all things in pensions it is not as simple as it seems.

First you need to know the process your pension scheme uses to calculate the annual increases.  Many schemes use the RPI in September, others the RPI in December, others may have a fixed increase.

For all those pensioners who are under the state retirement age the increase is applied by the pension scheme to all of the pension.  But why say all of the pension?  This is where the complications arise.

The great majority of DB pension schemes are contracted out of SERPS (now the State Second Pension).  In order to contract out the scheme had to guarantee to pay a pension of at least an amount broadly equivalent to the SERPS which you would have received if you were not contracted out.  This is the Guaranteed Minimum Pension (GMP).  It is also the Contracted Out Deduction you see on statements about your State Pension.  Contracted Out Deductions are not a decrease in your State pension but the GMP paid with your occupational pension.

GMPs are increased by an order laid in parliament each year and normally it is the same as the increase applied to the basic State pension – or the RPI in September.  This sounds simple enough, but …

Increases in GMPs for people below State pension age are paid by the pension scheme.  When you reach State pension age things change and this is where it gets complicated.

For all Contracted Out service prior to April 1988 all of the GMP increase is paid with the State pension.

For all Contracted Out service from April 1988 to April 1997 increases in the GMP of up to 3% are paid by the pension scheme.  Any increase above 3% is paid with your State pension.  For this year the RPI in September 2006 was 3.6%, so 0.6% was paid with your state pension

GMPs are not accrued after April 1997 (the date the 1995 Pensions Act had effect).

So what is the effect of this in how the scheme calculates your pension increase?

Assume:                                                     £

Gross pension                                   3,750.00
Total GMP                                             850.00
Post 88 GMP                                        150.00
Pre 88 GMP                                          700.00
RPI 4.5%

The increase is calculated as follows:
Gross pension                                    3,750.00
Less Total GMP                                     850.00

Pension in excess of GMP                   2,900.00
Apply increase of 4.5%                          130.50
New Scheme Pension                         3,030.50 (a)

Post 88 GMP                                          150.00
Increase 3.0%                                             4.50
New Post 88 GMP                                 154.50 (b)

No Increase to Pre 88 GMP                   700.00 (c)

New Pension payable (a)+(b)+(c) =    3,885.00  = 3.6% increase, not 4.5%

£2.25 will be payable with your State pension from the Post 88 GMP
£31.50 will be payable with your State pension from the Pre 88 GMP.  Please note that because of this, the Pre 88 GMP received from the pension scheme will always remain the same.

In general if your scheme uses the September RPI you can check you are getting the correct amount by adding up all of your pensions (occupational and State) and multiplying the total by the RPI figure (1.045 in the case above).  This should be the total you receive from April.

The Government have decided to apply the average earnings increase to the State pension in 2012 (or maybe by 2015).  However it is not the intention to increase the GMP by average earning, this will probably remain as the RPI in September, so complicating the calculation.

For those with different months for the RPI the only way to check is by doing the calculation above – always assuming you know how much pre and post 88 GMPs you have.