Warning over pension clawback - could it hit YOU at state pension age?

'Pension clawback' means your final salary pension might be cut when you reach state pension age.

The reason for this originates in rather arcane arrangements dating back to the dawn of the welfare state in the 1940s - and many pension schemes have since changed their rules or phased out the practice.

But if you are due a final salary pension via a current or old employer it is worth paying close attention to all information on the paperwork you are sent - and any choices you are being asked to make – especially in the run-up to retirement.

If you discover your scheme operates 'clawback' it's most important to fully grasp the rules, particularly if you retire before 66 and so will see a drop in your work pension after you start receiving your state pension.

Be prepared in advance, and ask questions of your scheme about the impact on you personally, to avoid any nasty shocks to your budget later in retirement.

Clawback has become controversial over the years, as we will explain below, because people are understandably exercised by a sudden loss of income when they don't expect it or haven't had an explanation.

Here's what you need to know about pension clawback...

Pension schemes use different names for this and it's worth knowing the financial jargon.

In addition to clawback, you might hear references to integrated pensions, state pension offsets and bridging pensions.

Arrangements for 'integrating' work and state pensions began back when the modern welfare state was created, which led to more people paying National Insurance from 1948.

Final salary (also known as defined benefit) pension schemes, both private and public, wanted to take account of more staff now receiving a state pension.

They sought to prevent schemes themselves or individual members overpaying contributions or doing so unnecessarily, just to duplicate benefits.

The rules for doing this and the calculations involved varied, and changed over time (if you're interested in the history, the House of Commons Library published a briefing on pension clawback in 2020).

Nowadays, most private sector final salary pension schemes are no longer linked to state pensions. Public sector pension schemes stopped taking them into account decades ago, except for service before 1980.

But some work schemes are still designed around them, and the result is that payments may be cut when a member reaches state pension age, to adjust for lower contributions made earlier by the scheme itself and its members.

The size of the reduction depends on the scheme, but it is a fixed amount and usually works out at a few thousands of pounds a year. This has a bigger impact on someone with a small pension than a larger one.

Clawback is sometimes embedded in a scheme's rules and will kick in automatically. However, some schemes offer workers the option of taking a higher 'bridging' pension - just until they reach state pension age - or a lower 'level' one.

They work out the cost to end up being the same either way, but people who get the choice can find it convenient to have a temporarily higher income while they wait to get a state pension.

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This is why you should read pension documents carefully in the run-up to retirement, so you know where you stand if you are affected by clawback (or a myriad other important matters).

If you are not sure, or don't understand the information you are sent, ring up or email your scheme and ask if it is has clawback arrangements.

Staff should be prepared to take the time to answer and explain any impact on you individually - better now than when you reach state pension age and are surprised by a sudden cut in your work pension.

If you do not know beforehand that clawback is going to reduce your work pension when you reach state pension age, you will understandably feel aggrieved - and it causes hardship in some cases.

Clawback was condemned by some MPs as outdated and punitive during an adjournment debate in the House of Commons in April.

Several cited constituents who had seen cuts of several thousand pounds, amounting in some cases to 13 per cent or 16 per cent of a pension, and there were calls for abolition of clawback.

Criticism was aimed in particular at a Midland Bank pension scheme, now run by HSBC, which is opposed by the Midland Clawback Campaign and the union Unite. See the box below for HSBC's stance on clawback.

Those against clawback often point out that it is regressive, in that fixed reductions disproportionately affect people with smaller pensions, who are often women.

Pension firm PensionBee says: 'As pension clawback is a fixed cash amount deducted from your pension - unlike other charges which usually deduct a percentage of the pot - its impact on your pension can vary.

'Those with larger pensions will be less affected, whilst smaller pots can see a substantial loss.'

It offers the following example: 'If you received £50,000 a year from your workplace pension scheme, then a fixed pension clawback of £2,500 a year would equal a 5 per cent deduction every year.

'However, if you received £10,000 a year from your workplace pension scheme, then that same fixed £2,500 clawback would equal a 25 per cent cut to your annual pension income.'

On its website, PensionBee says: 'Whilst most schemes have capped or withdrawn clawback, it's worth checking if you could lose out on a chunk of your pension.

'Those most affected are the lowest income workers, often women, and those seeking to retire early.

'If you're enrolled in a pension clawback scheme, it's likely you aren't even aware yet. One of the issues is poor communication, with few people affected aware of its importance.'

PensionBee suggests asking your workplace pension scheme directly or checking your company handbook, and considering making additional contributions to offset the future loss from pension clawback.

Successive governments have declined to force pension schemes to end clawback arrangements.

The Conservative former Pensions Minister Guy Opperman said in 2017: 'These schemes were designed to avoid additional contributions from sponsors and members by taking account of some or all of the state pension when calculating the amount of occupational pension payable.

'The arrangement is set out in scheme rules which would have been available to members when they joined the scheme.

'Such arrangements are not a requirement of Department for Work and Pensions legislation. It would not be right to compel schemes to withdraw this integration arrangement.

'That would amount to a retrospective change imposing significant additional unplanned costs. Pension scheme rules on the calculation of benefits are many and varied, and must remain a matter for employers and scheme trustees to decide.'

At the House of Commons debate on clawback in April, the current Labour Pensions Minister Torsten Bell gave a lengthy response which you can read here.

He said: 'I appreciate that that type of scheme can be controversial, thanks to the change in the private pension income involved.

'All of us sympathise with anyone who expected a straightforward income increase when their state pension kicked in, only to find that things were much more complicated than that. I have read and listened to representations on this issue myself.'

He went on: 'Integrating an occupational pension scheme with the state pension was a core design of some schemes, and that has pros and cons.

'It used to be a common feature of final salary schemes, covering almost half of schemes, according to one survey from the early 2000s, although it is far less common today.'

Bell said all pension schemes are required by law to provide every member with basic information, either before they join or very shortly afterwards. If someone has not received clear communication they can complain via an internal dispute procedure, and after that to the Pensions Ombudsman.

He added: 'I owe it to this House to be clear that we cannot retrospectively change the benefits schemes offered to their members. Any legislative change would affect all integrated schemes, risking the future of some that are less well funded.'

Rosie Hooper, chartered financial planner at Quilter Cheviot, has dealt with clients whose pensions are reduced by clawback.

She says: 'Pension clawback often trips people up simply because they don't understand it, and they haven't factored it into their budget.

'The reality is that the reduction isn't usually huge, but it's the surprise element that causes issues.'

Hooper says she always explains clearly what a client who is affected should expect.

'It's not that the whole state pension gets deducted which is a common misconception. It's about how some schemes reduce the income they pay once the state pension kicks in. It's not a hidden charge, but it needs to be properly understood.'

She says starting to receive the state pension allows people to reduce the income they need to take from other sources, but the step-down in cash flow has to be planned for and built into a retirement plan.

'It's also worth remembering that the state pension used to make up a much bigger share of someone's retirement income,' she adds: 'Today, it's a smaller piece of the puzzle, which makes planning around it even more important.'

Simon Taylor, head of defined benefit at pension consultancy Barnett Waddingham, says clawback was typically part of the design of defined benefit (final salary) pensions that remained 'contracted in' to paying second state pensions (Serps or S2P).

'The design meant that both the company and the members paid higher National Insurance, and members generally built up full state pensions,' he explains.

People in pension schemes which 'contracted out' of paying more NI usually get lower state pensions.

'Clawback' is essentially a way to integrate the scheme benefit with the state benefit - if it didn't exist, pensions would have cost the company and member more,' says Taylor

'As a result, members would have had lower take-home pay over the course of a career.'

He says there are lots of ways for clawback to happen, but obviously if it comes as a surprise it can be poorly received - and communications to scheme members weren't always as thorough as they are today.

'For people hitting state pension age now, it is all likely long-forgotten, and so can feel like a harsh practice,' he says.

'In reality though, the process has its roots in a sensible cost/benefit balance - and the alternative is being in a contracted-out scheme and paying lower National Insurance so getting a lower state pension, or being in a defined contribution scheme and likely receiving far less in the long run.

'Defined benefit pensions remain impressively generous - however, the responsibility sits with the scheme to ensure members understand the realities of their benefits and if and when any deductions will be made.'