Mind the pensions gap: who’s at risk and what to do about it

Rodney Smith, a 73-year-old former civil servant, had planned carefully for his retirement, living fairly modestly to build a reasonable level of savings for later life.

So the former economist with the Northern Ireland Department for Education was shocked to receive a letter last November saying that his pension had been overpaid by £1,800 and the scheme wanted the money paid back.

“I was rather angry to receive this,” says Mr Smith, who retired in Scotland.

“In my email to Civil Service Pensions, I said it should be their responsibility to pay the correct amount. I accepted the amount I was given in good faith and should not have to repay it.”

After challenging the letter, Mr Smith has not been asked to repay the £1,800, but his retirement income was lowered to the amount now deemed correct.

Across the UK, tens of housands of people could be in for similar shocks as pension schemes across the land complete a massive record-checking exercise, which is throwing up significant errors in pension records dating back four decades.

More than 10,000 retired members of the UK civil service are expected to receive letters advising of reductions to pension payments this year — just as Mr Smith has done — after the Civil Service Pension Scheme identified £22m of overpayments.

Similar letters are also expected to be sent to thousands of retired private sector workers as their workplace retirement funds uncover errors dating back four decades.

What is more, state pension payments could even be reduced as a direct consequence of mistakes being uncovered in the same record-checking exercise.

The FT has discovered that behind the scenes, consultants, investment advisers and trustees are agreeing between themselves how incorrect pension payments should be amended, putting savers in a confusing position. Some may not even know their benefits have been cut.

Here, we explain how the problem has arisen and what can be done if your scheme asks you to pay back an overpaid pension.

What is the issue?
What is driving the pension adjustments is a hugely complex record-checking exercise which began in 2014. The UK tax authority is seeking to marry its records with those held for millions of private sector and public sector workers in “final salary” pension schemes.

More specifically, workplace schemes and HM Revenue & Customs (HMRC) have been comparing records concerning “guaranteed minimum pensions” — an entitlement offered to millions of workers who “contracted out” of contributing to part of the state pension between 1978 and 1997. Any errors in the way this guaranteed minimum pension has been calculated will lead to revisions of both private and state pensions.

What is contracting out?
Before 2016, the state pension consisted of two parts. First was the basic state pension, to which people built entitlement on the basis of their national insurance record. The second element was the additional state pension, which was related to earnings, with higher earners able to build a bigger state pension entitlement

From 1978, it was possible for workers to “contract out” of this second element, known as the State Earnings Related Pension (Serps). The incentive for employers and employees to do this was that they both paid a reduced rate of national insurance. In return, the workplace pension scheme had to provide a guaranteed minimum pension (GMP) to the employee.

“The GMP is equivalent to what the member would have got from the state pension had they not contracted out of Serps and paid a reduced rate of national insurance,” says Chris Tagg, partner with Barnett Waddingham, a financial consultancy, which is helping several pension schemes with reconciliation exercises.

Rules were set by the government on inflation proofing these minimum pensions. For example, pension schemes are required to index GMP rights accrued between 1988 and 1997 in line with the consumer price index, subject to a 3 per cent cap.

Why are some records wrong?
HMRC keeps records of GMP entitlements for contracted out workers. These records are then used to calculate state pension payments for the same workers — plus the subsequent annual uprating of GMP rights by occupational schemes.

However, schemes are finding that their GMP records do not match those held by HMRC, due to missing paperwork and inaccurate records dating back four decades. HMRC records are assumed correct, unless the scheme can prove otherwise.

“It is not unusual for HMRC and the administrator of a contracted-out pension scheme to hold different information concerning which employees were contracted out of a state additional pension, which periods of service were contracted out, or the rate of compensation,” says Philip Titchener, GMP specialist with Willis Towers Watson, the pension consultants.

“Without an exercise to reconcile these differences, the member may receive the wrong amount of GMP, the wrong amount of additional state pension, the wrong amount of [their company pension], or occasionally, all of the above.”

Why are these problems only surfacing now?
At present, most schemes should reconcile records with HMRC when the member reaches GMP age (60 for women and 65 for men).

However, as contracting out was ended in 2016, HMRC is closing its GMP reconciliation service later this year. This has prompted a push by company pension schemes to reconcile all records by the October 2018 deadline. When GMPs are incorrectly recorded, it leads to wrong annual increases being paid. This can result in overpayments and underpayments.

What is the link with the state pension?
When a person reaches state pension age — currently 65 for men, and set to reach 65 for women by the end of this year — any additional state pension they have accrued is adjusted for previous periods of being contracted out, when a lower rate of national insurance was paid. This “contracted out deduction”, which appears on the new state pension statements, relies on GMP records held by HMRC.

Who is affected?
Private and public sector workers who were contracted out between 1988 and 1997, the period in which members could accrue GMP rights, and who have not previously had their GMP checked. Those affected include those who have yet to retire, and those who are already receiving their pension.

What has the reconciliation uncovered?
Initial feedback from the industry suggests that up to a quarter of GMP records could be wrong. Most errors are said to be modest, but some overpayments are known to have reached six figures in a minority of cases.

In 2017, the Civil Service Pension Scheme reported its GMP review had uncovered £22m in overpayments, likely affecting around 10,000 or so retired civil servants. There were also 5,600 members who had been underpaid to the tune of £36 per member.

Reconciliation exercises are still under way in the biggest public sector schemes including the NHS and teachers’ pensions plans.

How big are the errors?
A recent review of a private sector scheme with 1,000 members by Willis Towers Watson found GMP errors for most people were small (less than £50 per pension a year — and less than £200 in previous overpayments or underpayments).

However, about 80 people in the scheme had a difference of more than £50 a year to their pension. A dozen members were found to have overpayments or underpayments of more than £5,000 in total. And a slightly larger group of members had errors that were expected to alter their pension by more than £10,000 over their lifetimes.

I’ve seen an overpayment of £60,000 and that pension had been in payment since 1983

“There are going to be some winners and some losers, says Mr Tagg of Barnett Waddingham.

Those likely to see the biggest errors are the oldest pensioners, where the GMP makes up a larger slice of their pension.

“I’ve seen an overpayment of £60,000 and that pension had been in payment since 1983,” says Matt Ashton-Smith, a consultant working on GMP reconciliations.

“Once the benefit was recalculated to the correct amount, it effectively halved the pension.”

What about the state pension?
The government has also been writing to pensioners where errors have been identified in GMP records.

If the individual’s GMP changes, this means the amount of the contracted out deduction on their state pension will also change. The Department for Work and Pensions says the amounts that may have been underpaid or overpaid will depend on an individual’s unique circumstances. “People’s pensions could increase or decrease,” it says.

What position are schemes taking on overpayments?
It varies. As a rule of thumb, the better-funded private sector schemes are more likely to write off overpayments, but struggling schemes may seek to recover them.

The Cabinet Office says that it won’t seek recovery of the £22m in overpayments it identified at the civil service, but will adjust pensions to the correct level.

The Scottish Public Pensions Agency and the Local Government Pension schemes are yet to declare how they will handle GMP-related overpayments.

The Pensions Regulator says: “Trustees are entitled to request repayment of any overpayments caused by an error. However, where the trustees were responsible for the error they should allow a reasonable time for the payments to be made, and offer the option of paying back in instalments.”

The DWP says it will not attempt to recover overpaid state pensions, but will adjust future payments to correct levels.

What about underpayments?
Trustees are obliged to make good any underpayment in the pension. The underpaid will receive a lump sum and an uplift to their annual pension.

How are schemes handling overpayments?
In practice, company schemes and trustees are all working out their own approach to the problem with the support of professional advisers and often lawyers.

Legal experts say trustees are obliged regularly to give members details of their benefits and to correct any errors that may have occurred in the past.

“Trustees can ask the member for the money back and can take action to recover the outstanding sums,” says Rosalind Connor, partner at ARC Pensions Law. In addition, it is often possible to reduce future payments in order to recover the overpayment already provided, which tends to be easier to get the member on side.

However, there is no guarantee that individual members will be informed about how an overpaid pension will be recovered.

Some trustees may impose a repayment schedule without the agreement of the member. Trustees could also look to change the structure of a pension, which is made of different slices attracting different rates of annual increases. Industry officials say this is something members may not be told about — particularly if the tweak is small.

“On occasion, when the change is very small, trustees may choose not to send out a correcting communication, but this is unusual,” says Ms Connor.

For larger amounts, trustees will usually propose a recovery method for the member to agree to, sometimes asking them to sign and return a form authorising a monthly deduction from their pension, says Mr Tagg.

“Trustees will consider the size of the overpayment in absolute terms and relative to annual pension and also the length of time over which the overpayment was received. Typically, recovery would not be more than, say, 25 per cent of the monthly pension and the recovery period would, if possible closely match the overpayment period.”

If the mistake that led to an GMP overpayment was made more than six years ago, it may be possible that overpayments do not need to be repaid, says Michelle Cracknell, chief executive of The Pensions Advisory Service.

“This will depend on if it was reasonable for the mistake to have been found earlier than it was. This is a complex area, so we would suggest that people talk to us.”

Members will usually be given the option to respond with an alternative repayment plan, perhaps within certain limits set by the trustees. They could also opt to pay the amount back in one go — which advisers say happens more often than you might think.