Defined-benefit pension schemes: Rebate change in 2016 may leave you out of pocket

Employees in defined-benefit schemes are held up as the lucky ones, but the state pension scheme will be overhauled in April 2016

Don't count your retirement money yet: employers will stop receiving a pension rebate next year and their staff may lose out (Getty Images)

Private sector employees who are still members of final salary or other "defined benefit" pension schemes might count themselves lucky to be in such attractive retirement arrangements – but they could well find that the terms they receive are downgraded in a year's time.

In April 2016, the state pension scheme will be overhauled – and a side-effect of that will be the ending of a very useful rebates system for all defined-benefit plans.

As of that month, employers will stop receiving a 3.4 per cent national insurance rebate set up as an incentive to "contract out" of the secondary state pension. This means that the costs of running these schemes will go up. "A number of employers will probably seek to pass on the cost – as it would otherwise be a cost to them," says Tim Smith, a pension specialist at the law firm Eversheds.

So who will the extra cost be passed on to? Employees. The main options facing private sector companies, according to the actuary Mercer, are to require their workers to pay more in the form of pension contributions or to reduce the pension benefits offered.

"For an employer with 1,000 staff, we're talking about a substantial amount of money," says Malcolm McLean, a consultant with the actuary Barnett Waddingham and former chief executive of the Pensions Advisory Service. "I'd certainly expect many employers to look at the possibility of doing something about it – not necessarily closing down the scheme but changing the accrual rate or pushing back the individual's retirement age, or increasing the level of contributions an employee has to pay."

Public sector workers are, however, far less likely to be affected. In 2011 the Government announced that public sector schemes would be protected for 25 years from negative changes.

However, members of both private and public sector defined-benefit schemes could see their takehome pay fall slightly in April next year. Employees who are in "contracted out" schemes of this type now receive a national insurance rebate of 1.4 per cent, which they will be denied from April 2016. Losing that rebate on their national insurance bill would have the same effect as losing a discount on their income tax rate.

This could translate into losing £13 a month, for instance, for someone earning around £25,000. But it could be that this slight loss in net income is hidden by other changes – in tax rates or allowances or overall pay levels. "It may be that it goes under the radar for some employees," says Laith Khalaf of the financial adviser Hargreaves Lansdown.

Why has there been so little publicity about this? One reason is that many organisations may be still be tied up looking at the implications of the many changes already being applied to retirement money – including the "pension freedoms" that came into force on Monday.

"That is putting quite a strain on employers," Mr Khalaf says. "I imagine that schemes will be writing out to people in the not too distant future."

Members of schemes would do well to read the communications they receive on their pensions. One issue that The Independent has exposed – but few employers running defined-benefit schemes have explained – is that government-paid inflation increases on a portion of private pensions will stop for people reaching retirement age after 5 April 2016.

The value of those increases is estimated at £20,000 per individual over the course of their retirement. Although many people will be better off under the new single-tier pension scheme coming in from April 2016, there will be complications for many individuals – and the more we understand about our own position, the better prepared we will be.

pensionsadvisoryservice.org.uk

Nicky's tale: 'I feel very cheated'

When she retires at the age of 67, Nicky will rely on her pension as her main source of income. Now in her 50s, she thinks more often about how she will get by financially in retirement. She is rather hurt to hear that – if nothing else changes – her net pay will go down next April.

"I feel very cheated over any reduction, no matter how little," says the public sector worker, who says she signed up for one thing and will now be getting something less attractive. "Who would be happy with that?"

While she will be hit on the pay side, Nicky – as a member of a public sector scheme – is less likely to suffer negative effects from the April 2016 change in her pension terms. "I'm worried about money in the future, and would definitely feel relieved if it were being protected somehow," she says.

So many changes have already been made to her pensions – not least the increase in the pension age from 60 to 67 – that she finds the whole subject a sore point.

"She thinks she will be far less comfortable than colleagues who have already retired, as well as "much more world and physically weary".