Pension divide: some Britons could be £1,500 worse off by April 2024

Calculations by interactive investor show £1,500 income gap between pension schemes based on their inflation protections.

New calculations from interactive investor, the UK’s second-largest retail investment platform, reveal that some pensioners are much more protected than others when it comes to inflation, with those with inflation-protected pension schemes £1,500 better off by April 2024 than those with capped inflation protection.

Some pension schemes, including four of the main public sectors pensions (teachers, NHS, armed forces and local government) are inflation-linked and uprated each April based on CPI inflation in the previous year. These pensions increased by 10.1% this April, in line with the increase in the state pension, protecting pension savers and pensioners from inflation.

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In contrast, private sector final salary pension schemes often have capped yearly increases, meaning that pensioners’ incomes will only rise by a maximum of around 5% each year. Pensioners with these schemes lose out in times of high inflation.

Different pensioner groups

Assumptions: final salary calcs assume pension income of £20,000 in 22/23, inflation of 7% based on Bank of England May forecast for Q3 2023, defined contribution based on £410,000 pot with income of 4%.

Detail on the calculations

Scenario 2 and 3 - based on someone receiving a pension income of £20,000 in tax year ended 22/23, in addition to the state pension. Their income then increases either by inflation (10.1% in September 2022 and expected to be 7% in September 2023, based on May Bank of England forecast) or by 5% in line with a typical inflation cap.

Scenario 4 - based on someone with a defined contribution pension pot who earns the average wage in their 20s, contributes 8% of their salary to their pension (5% employee and 3% employer contributions) for 40 years and achieves 5% investment growth net of fees, assuming contributions increase by 2% pa. Their pension income is based on a 4% income from the resulting pension pot of £410,000.

Other key pensioner stats:

• Private defined benefit pensions - in 2022, 9.6 million were relying on private sector defined benefit pensions, with only 0.9 million still actively accruing benefits -  https://committees.parliament.uk/work/7369/defined-benefit-pension-schemes/#:~:text=The%20number%20of%20private%20sector,of%20their%20expected%20retirement%20income.
• Public sector pensions - at 31 March 2020, there were more than 8 million members of four of the largest public service pension schemes (the armed forces, civil service, NHS and teachers’ pension schemes), of which 2.8 million were retired and receiving pension benefits and 5.2 million were either current or former employees. Around 25% of pensioners and 16% of the working-age population are members of a public service pension scheme. https://www.nao.org.uk/reports/public-service-pensions/
• Membership of DC Master trusts has increased was just over 23.5 million in January 2023 DC trust: scheme return data 2022 to 2023 | The Pensions Regulator

Alice Guy, Head of Pensions and Savings, interactive investor says: “It’s easy to assume that all pensioners are similar when it comes to income, but that couldn’t be further from the truth. In fact, there are four distinct groups of pensioners when it comes to pension income – those relying solely on the state pension; those with pension pots, relying on investment performance; those with a final or average salary pension, often rising at a maximum of 5% per year and the luckiest of all - those with an inflation-linked final or average salary pension.

“With inflation remaining painfully high, a huge gulf is opening up between those with inflation-linked pensions and those with a capped pension increase, often 5%. This gap will only widen the longer high inflation continues, with capped pension incomes worth less in real terms as time goes by. The four main public sector pensions are directly tied to CPI inflation and rose by 10.1% this April, in line with CPI for September 2022. In contrast those working in the private sector often have their annual increases capped and will see the spending power of their pension eroded in times of high inflation.

 “Pensioners with capped income growth could be £1,511 worse off by April 2024 compared with someone with an inflation-linked income. And because of the way pensioner income is calculated, this gap will widen over time as future increases are based on current values so even small differences really mount up.

 “There’s also an increasing group of people reaching retirement age with a defined contribution pension pot, meaning they don’t have a guaranteed income and their pension income will depend on investment performance. Most companies closed final salary pension schemes to new members during the 1990s and early 2000s, instead offering defined contribution pensions where individual employees invest in their own pension pot. This group can still achieve a comfortable retirement if they regularly invest over the long term in a balanced portfolio, but they’re unlikely to beat the gold-plated returns of those with a final or average salary pension.

 “There’s a myth that all pensioners are rich, but that’s simply true. Many retirees have no workplace pension at all, relying solely on the state pension. Auto-enrolment rules came into force in 2012, and before that date many smaller employers didn’t offer a workplace pension. It was possible to work for your whole working life and have nothing to show for it, apart from the state pension."