Pension increase exchange: what is it and should you take it?

A pension increase exchange swaps some future yearly rises on your final salary pension for a higher pension now. Here is what you gain, lose and check.

A pension increase exchange (often shortened to PIE) usually arrives as a letter from your scheme. It is not a transfer: your pension stays where it is, but it changes how that pension grows from then on. Wondering how an exchange letter sits beside your other retirement income? Pop a daytime number onto the form on this page; an unhurried, unbilled call follows, and the FCA-authorised adviser holds the offer up against your figures.

What does a pension increase exchange offer swap?

The industry's code of practice defines it as an offer under which members of a defined benefit scheme "are offered an enhancement to their pension income (or another inducement) in return for surrendering all or part of their future pension increases." A Department for Work and Pensions paper puts it more briefly: members "are given the choice to swap some or all of their non-statutory pension increases for an increase to their pension."

The word that matters is non-statutory. The law sets a minimum yearly rise for private-sector schemes: section 51 of the Pensions Act 1995 says a pension attributable "to pensionable service on or after 6 April 1997" must be "increased annually by at least the appropriate percentage." The DWP's wording matters here: what members swap are non-statutory increases, meaning rises beyond those the law requires. Schemes can also limit which pension qualifies. As one example, the BT Pension Scheme's member booklet says "You can only use PIE for pension that you built up before 6 April 1997." Your own offer letter says which slice of your pension is involved. For the legal minimum, see whether final salary pensions increase.

Why would a scheme want you to give up your increases?

Because it is likely to lower the employer's costs and risks. The Pensions Regulator (TPR) says that where a member accepts an offer of this kind, the employer's pension liability or risk is likely to be reduced, while for members the risk of a loss in the long run will usually increase.

TPR also warns that "An IE offer is often set at below 'cost-neutral' terms in order to reduce an employer's pension liabilities, and in this situation there is a heightened risk that members will be worse off." It accepts that a small minority of members may have personal circumstances that leave them better off.

These offers are common. The DWP paper, published in February 2017, used the regulator's figures to report that among the incentive exercises accepted in the 2015/16 year, "by far the largest proportion (37,337) was in respect of a Pension Increase Exchange offer".

What you gain and what you lose

The gain is a bigger pension from the first payment. The BT booklet says the option "gives you a higher initial pension in exchange for giving up some of your annual pension increases."

The cost comes later and keeps growing. The same booklet says "while an annual pension with PIE will start higher, eventually it will fall below the same annual pension without PIE." The age at which that happens, the break-even age, depends on how fast prices rise, which nobody can know in advance. TPR notes that losses can come from factors specific to the individual, such as life expectancy, or from the wider economy. The industry code asks that projections "continue to at least the average expected lifetime of a member based on the same age and sex" and "be based on a suitably wide range of future inflation assumptions", so check that your offer shows more than one inflation path.

Your partner's position matters too. The code says "Consideration should also be given as to how to fairly communicate any impact on dependants' pensions", so look for a line in the offer on what happens to a spouse's or civil partner's pension. How a swap treats a widow's, widower's or civil partner's pension under your scheme's rules can be talked through, free, by an adviser who rings you when your details reach them from this page's form. Read what a final salary pension pays when you die for how those benefits usually work.

Which part of your pension can be swapped?

That depends on your scheme's offer: BT's pre-1997 limit is its own rule, not a general one, and the letter should say which slice of your pension is covered. A guaranteed minimum pension has its own rises: see whether a GMP increases. An exchange is also separate from tax-free cash. The BT booklet describes PIE as something you can add to its standard benefits or its maximum lump sum option, so there the two sit side by side. Read how a final salary pension works, how a final salary lump sum is worked out and your choices at retirement to see where an exchange fits.

What protections should come with an offer?

TPR's statement, issued in July 2012, says an offer should be clear, fair and not misleading, so that members can understand the implications. It also says that "Fully independent and impartial financial advice should be made accessible to all members and promoted in the strongest possible terms", though for some pension increase exercises "financial advice may not be required; however, the structure of the offer should provide detailed guidance instead." TPR commends the industry code to employers and their advisers and says it takes the code into account in any regulatory proceedings about these exercises.

The code, Incentive Exercises for Pensions: A Code of Good Practice (version 2, January 2016, the version TPR links), calls itself "a voluntary Code". The Pensions Ombudsman and the Financial Ombudsman Service take it into account, where appropriate, when handling a complaint. For a one-off exchange offer it says:

• Either advice is given, or the offer must pass a value test: "the Balanced Deal Percentage must be 100% or more", and members must take guidance before accepting. Below that, advice should be strongly recommended, and a member who declines it signs to say so.
• If that percentage is under 100%, the offer should say plainly what the employer expects to gain and members to lose if it is accepted.
• Advice paid for by the employer must not be linked to how many members accept, or involve commission.
• Members should have at least three months to decide, and at least two weeks after the last piece of advice or guidance, and two weeks after returning the option form to change their mind.

There are limits. Where the pension that can be modified under the offer is £500 a year or less, a proportionality threshold applies: advice is not required, though guidance should be made available to members who want it. The code also does not cover an exchange option a scheme builds in for members approaching retirement, though it does apply if existing pensioners are made a similar offer. For an at-retirement option, ask the scheme what information and help you will get.

How to weigh a pension increase exchange offer

Points worth settling before you reply:

• Which slice of pension is covered, and your pension with and without the swap, year by year.
• The break-even age under more than one inflation path, set against your own and your partner's health.
• What the swap does to the pension your spouse or civil partner would receive.
• Whether your other income, such as the State Pension, will cope if your scheme pension rises more slowly.
• Whether the scheme pays for advice or guidance, and the deadline.

A swap is a different decision from a transfer out, which carries its own risks. Still weighing the swap? Completing the form on this page earns an unbilled call, and your exchange offer can then be taken apart point by point by an FCA-authorised adviser.

Pension increase exchange questions

Is a pension increase exchange the same as transferring my pension?

No. A transfer moves your rights out of the scheme, while an exchange changes the rises on pension that stays in it. The code treats them as different types of exercise, a transfer exercise and a modification exercise.

Do I have to take advice before accepting an offer?

Under the code, a one-off exercise should provide advice or, if it passes the value test, guidance that you must take before you can accept. Where the pension the offer could change is £500 a year or less, advice is not required, though guidance should still be readily available.

Is an at-retirement pension increase exchange option different from a one-off offer?

It can be. A scheme may build the option into its rules so that members approaching retirement are routinely asked, and the code does not apply to introducing that kind of option. Ask the scheme how it will explain the choice before you decide.