How does the Boots pension agreement with L&G affect my early retirement scheme? Steve Webb answers

I hope you can give me and other members of the Boots defined benefit scheme some advice.

The recent announcement that the Pension fund Boots has been bought by Legal & GeneraStandard letters followed to all members describing the buyout.

The letter also contained a change to the early retirement scheme. Previously, there was no penalty for increasing your pension from age 60 to 65, and a 4 percent reduction for each year you took out before age 60 up to age 55.

Like many others (I'm in my fifties), I was actively planning to take my pension early and made financial arrangements based on the figures in the scheme.

This has now changed without notice, and as far as I know no grace period.

I have tried to contact the pension department by email and am currently waiting for a response. Can you give any advice that may be useful to myself and other members?

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Steve Webb replies: To help you understand what's going on here, it may be helpful if I start by explaining how salary-related pension schemes work, and how the trustees try to ensure there is enough money to ensure your pension is paid out.

With most schemes, employer and employee pay contributions to build up a fund, so that when you retire, money is available to meet the pension commitments made to you.

In decades past, money in such funds would typically have been invested for growth, probably with a relatively high allocation to shares or equities.

Stock markets go up and down, so there is a risk to this strategy. However, over decades, this higher-risk strategy will typically generate higher returns, increasing the amount of money in the fund.

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Many of these schemes have now been closed and so the balance between employees and pensioners is shifting.

Parallel to this shift in scheme membership, the way in which money is invested in the scheme will also have changed.

Most salary-related pensions have seen a steady decline in risk, with shares sold and government bonds and similar assets bought. These typically generate lower but more predictable returns.

This gives the scheme more certainty that it will have the money it needs to fulfill the pension promises it has made and also reduces the risk that the scheme will have to call on the employer for a top-up.

Some pension schemes will continue in this way, steadily paying out pensions as they come due, possibly for decades to come.

In some cases, however, trustees will decide that they want to secure the participant's pension once and for all.

They do this by carrying out a 'buyout' – a transaction between the scheme and an insurance company.

What is a redemption of a pension plan?

In simple terms, the trustees transfer all the assets of the pension scheme and in return the insurance company promises to pay an agreed schedule of pensions for as long as they are due.

One of the attractions of such a deal for trustees – and for members – is that it is widely believed to increase the certainty that pensions will be paid in full.

There is no longer direct exposure to the ups and downs of the financial markets and it does not even matter if the sponsoring employer goes bankrupt.

And while it's not impossible for a large insurance company to go bankrupt, they are held to very high “solvency standards,” which means they need to have a lot of capital to weather the economic ups and downs.

In many cases it is therefore a good thing to have your pension benefits 'bought out' with an insurer and is likely to increase the certainty that your pension will be paid out in full as long as you live.

However, an important point – which emerges from your experience – is that it is very important which pension promises the insurance company exactly fulfills.

In simple terms, the trustee will outline the rules of the plan and the benefits it wants to ensure, and will quote the insurance company a price for providing those benefits.

For most payments it is simply a matter of paying out according to the scheme rules.

However, some pension schemes may offer 'discretionary' benefits.

These are payments that members may not be legally entitled to, but can be made at the discretion of the trustees or employer – perhaps at times when the scheme's funding is in a good position.

An example might be in cases where the scheme rules only require inflation protection up to a maximum, but the trustees or the employer – on a discretionary basis – may decide to go further.

I understand that for some of these benefits the trustees have decided to 'lock in' some discretionary payments as part of the buyout agreement.

For example, the 'discretionary' benefit to surviving relatives will now be paid by the insurance company by operation of law.

However, it appears that the trustees have decided not to retain the apparent discretionary power to pay out pensions in full from the age of 60 rather than from the age of 65.

This is obviously a very important change for those affected as they would otherwise have received a full pension at the age of 60.

Unfortunately, the fact that some pension statements have been sent based on a retirement age of 60 rather than 65 is in itself unlikely to create a legal right as these are likely to emphasize that they are only 'estimates'.

It is the rules of the pension scheme that determine what people are entitled to.

From the administrators' perspective, they will have weighed the company's overall proposal and sought professional advice before deciding whether consummating the deal was the right decision.

I imagine that in making that decision they took into account the £500m of additional contributions that the company has committed to enable the scheme to obtain the additional long-term security from the insurance company, as well as the discretionary benefits that would be 'locked in' and those that would not.

What does Boots say about the changes?

To try to provide a better understanding of what happened and why, I have asked Boots a series of questions on your behalf and have posted my questions and the company's full responses below, which I hope will be helpful.

1. Was the option to receive a full pension at age 60 instead of 65 open to all scheme members, or was this subject to a threshold test (e.g. minimum years of service)?

Answer: The possibility of submitting a request to the trustee from the age of 55 to grant an early pension, which was not reduced for early payout between the ages of 60 and 65, applied to most participants to the scheme, but not for all.

2. Some participants have for years been making statements based on a full pension at the age of 60.

Have the trustees considered any form of transitional arrangements for those who may be close to 60 and have made financial plans based on those statements?

Answer: As you would expect, the trustee has obtained extensive legal advice regarding this important decision and the transaction as a whole.

The discretionary nature of the early retirement increase is clearly set out in the scheme rules. Pension quotes reflected the need to apply to the trustee.

A transitional arrangement applies to participants who have recently received an early retirement offer.

3. Why was the discretionary ability to take a pension at age 60 not transferred, as the trustees chose to transfer certain discretionary benefits (such as survivor's pensions) to L&G?

Answer: There was no legal obligation to do this. The buy-in transaction would not have been affordable if all discretionary benefits had been included.