Defined benefit schemes generally provide a “one size fits all” pension that doesn’t always provide the right mix of benefits, and trustees and employers are increasingly keen to ensure that members are able to take their benefits in a way that suits them.
We look at some of the key “member options” below.
Pension Increase Exchange (“PIE”)
Under this option, members exchange their “non-statutory pension increases” (i.e. increases above those required by the Pensions Act 1995) for a higher rate of pension that will not increase in the future.
This can be an attractive option for members who would value a higher starting income, although there is a risk that a member will be worse off overall if they reach the “crossover age” (the age at which the overall income received over their retirement would have been higher if they had not exercised the PIE option).
For employers, a PIE option can improve the funding position of the scheme, as members are usually given a proportion of the value of the future increases that are given up. The balance of the value is retained in the scheme to improve the funding.
Flexible Retirement Option (“FRO”) / Total Pension Increase Exchange (“TPIE”)
A FRO/TPIE involves the member transferring their benefits from the scheme to a personal pension, where they can draw their benefits in a way that suits them. This could include:
- A higher tax free cash lump sum than would be available under the scheme
- Pension increases to suit the member (including none at all)
- Choosing whether to provide for a spouse, and at what level
A FRO can be attractive for members who may not need all of the “standard” benefits provided by the scheme (for example if they are single or their spouse has their own source of income, or if they would prefer a higher starting pension that doesn’t increase in payment).
Bridging pension option
Another option is the bridging pension option. A minority of schemes already contain a bridging pension option as standard, but this flexibility can be added at a later date by amending the scheme rules.
A bridging pension allows a member to “reshape” their pension benefit and take a larger proportion of their benefits before state pension age (and a smaller proportion after state pension age) in order to help bridge the gap before their state pension becomes payable. The aim is to “smooth” the benefit payable over the member’s retirement, supporting members who retire before their state pension age.
As state pension age rises, this option is likely to prove increasingly popular, especially for members who wish to retire early.
Financial advice
Members may struggle to understand which options are suitable for them, and many employers provide access to an independent financial adviser (“IFA”) in order to assist the decision-making process.
The Code of Good Practice on Incentive Exercises applies to many (but not all) PIEs and FROs. The code is voluntary, but compliance with it is recommended in order to ensure that members are treated fairly.
It is important that employers choose an IFA carefully and take appropriate legal advice to ensure that the contractual terms adequately deal with matters such as data protection requirements and the allocation of risk.
How can we help?
Our Pensions Team has extensive experience of advising on the design and implementation of member options exercises. We’d be delighted to discuss your legal advice requirements with you.
