The State Pension reduction could significantly reduce your income in retirement once you start taking your pension.
If you are due to receive a defined benefit pension at retirement then you need to check to see whether your scheme will apply a State Pension reduction.
What is the State Pension reduction?
The State Pension reduction, also known as clawback, is applied to some private sector defined benefit pensions (also known as final salary pensions) at State Pension age.
It’s usually the case that you will take your defined benefit pension before State Pension age, so you will start off receiving a certain amount from the scheme.
If the scheme operates a State Pension reduction, then after a few years at State Pension age the scheme will reduce your pension income by a proportion of the State Pension that you start to receive.
For example, Ann started to receive her defined benefit pension at age 60. The income she received from the scheme was £5,000 per year. At age 67 her scheme applied a State Pension reduction of £1,140 which means going forward she only receives £3,860 per year from the scheme.
Ann is still entitled to her State Pension but her defined benefit pension income has been cut significantly.
This type of practice is perfectly legal and is used by many of the older bank pension schemes.
It should be stated in the scheme rules but many will not have understood what it meant at the time and would have probably forgotten about it.
There are various campaigns trying to get this type of practice abolished.
If you are impacted by the State Pension reduction then it will be a case of having planned your retirement on the basis of receiving a certain amount of income and then realising this will be cut part way through your retirement. So your plans may need to change.
How to avoid the State Pension reduction
If you have already started receiving your defined benefit pension income and your scheme applies the State Pension reduction then unfortunately there is not much you can do apart from hope that campaigning against the scheme forces them to change their rules.
However, if you have yet to start taking your defined benefit pension income then there may be a couple of options.
- Your scheme may offer you the choice of a higher starting income followed by a State Pension reduction or alternatively a slightly lower starting income that is not reduced giving you more clarity over the future.
- A transfer of your defined benefit pension into a personal pension which you then withdraw from as and when you like.
If you choose option 2 then it puts you back in control. You will need to request a Cash Equivalent Transfer Value from your scheme and the scheme will offer you a lump sum transfer value in exchange for you giving up your scheme income.
You must do this before you reach the scheme’s normal retirement age.
You then end up with a pot of money sitting in a personal pension and can withdraw as much as you like subject to tax.
The downsides to this approach are that your new personal pension will be invested and could go down as well as up. The more money you take out, the more chance your pension pot could run out early.
I am not saying it’s right or wrong to continue with a defined benefit scheme and the State Pension reduction, I just want you to be aware of all the options so you can see what suits you best.
If you would like to understand your pensions in more detail and which retirement options are best for you then please schedule a no obligation free 15-minute call.
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