One pension fund has started offering its members so-called ‘bridging pensions’, to allow them a higher pension until state pension age, in exchange for a lower pension later. What do trustees need to consider before making this route available to members? 

 

The Severn Trent Pension Scheme has introduced a bridging pension option this summer, saying the higher initial income – until the state pension starts – could allow people to retire earlier, with the bridging pension smoothing their income between actual retirement and state pension age.  

 

The state pension age will rise gradually to 67 by 2028 and could go up further, as the government recently ordered a review of the state pension age led by Conservative peer and former Treasury official, Baroness Neville-Rolfe. 

 

As state pension age is moving ever further away from most scheme’s normal pension age, a gap is opening up for those retiring before they reach 66 or 67. Many older workers who can afford it, or who cannot continue working, will want or have to retire earlier but realise there is a gap in income until their state pension starts.  

 

For those with no or little private pension income, this can have dramatic consequences; the Institute for Fiscal Studies recently found that the rise in state pension age from 65 to 66 has meant income poverty for 65-year-olds reached nearly a quarter (24%) by late 2020, up 14 percentage points. 

 

 

The Severn Trent scheme cites the ability to retire earlier than expected as a potential advantage of bridging pensions. However, it also warns that because the pension will be lower later, depending on how long a member lives, “there could be a point in the future when you become worse off financially by choosing the bridging pension option”. 

 

Other warnings include that the scheme’s pension will be reduced at the “expected” state pension age – decided at the point of retirement – regardless of any future legislative changes. With the decision depending on these and other factors, the trustees said they have arranged for Origen Financial Services to provide interested members with one round of paid-for financial advice. 

 

Bridging pensions can add to the complexity of a scheme, said Clare James, a client director at professional trustee firm PTL. “I have considered the introduction of a temporary pension on one scheme recently and can understand the potential attraction to members of having a higher benefit up front that steps down when the state benefits kick in,” said James. However, she noted that it can be problematic if the scheme has members who are close to reaching the lifetime allowance limit. 

 

This is not the only problem. Adding a bridging pensions option for members – perhaps in addition to pension increase exchange and other options – can make an already chunky retirement pack even heavier, said Liam Mayne, a partner at consultancy Barnett Waddingham. 

 

At one fund where a bridging pension was implemented, the retirement pack ended up particularly large, and early feedback from members indicated that it was overwhelming for them, he said. Therefore, trustees “need to think hard about the right trade-off between more options and making it more complicated – but potentially worthwhile for members”, he said. For trustees considering introducing this option it is “worth spending some time and money really streamlining communications as much as you can”, he said, to make them as easy to read and digest as possible. 

 

Funded financial advice, like Severn Trent put in place, should also be a consideration, he said, noting that for most members one round of advice is enough to whittle down the choices and make a decision. 

 

 

Trustees have to be careful about who they offer bridging pensions to, even if that means additional processes for the administration team. Mayne warned against simply maximising the saving for the scheme. 

“The big driver is cost and risk reduction,” as for other liability management exercises and depending on the terms, members get an option that is valuable, while schemes reduce cost and risk. But, with take-up relatively high – Mayne said he would expect between 25% and 50% from past experience – care is needed to ensure members do not regret their decision later. 

 

“They can be quite popular because you are giving members a lot more money today. With the way tax rules work, members can take a larger amount in tax-free cash, in some cases double,” he pointed out. “Our view is, trustees need to be careful about that because that’s potentially a lot of the value of the pension paid out to members very early on in retirement,” he noted, with people on lower pensions potentially left with little residual value once the state pension starts. 

  

Although the state pension will likely smooth income, trustees should not offer it to every member, he argued, to avoid making disproportionate savings on the backs of members. “There is a risk that as much as the communications point it out, it’s kind of lost on them that when the state pension kicks in, their benefits could drop, and potentially substantially,” he said. 

 

Despite this risk, a growing number of schemes have been introducing bridging pensions in the past two years, according to Mayne: “There is definitely an increase in schemes looking if it’s right for them.” 

 

What are your views on schemes offering bridging pensions?