Final salary pension

coloursixseven

I'm looking for some advice on my current situation. I'm currently in a company final salary pension that will pay 2/3 of final salary and my contributions have risen to 10% of salary.

I know that final salary plans are seen as excellent, secure pensions. I've never bothered to do the sums on it before, as I was sure that paying 5% of my salary out to get 66% of it back on retirement was a good idea, but the rise to 10% has me wondering if it's really that great.

Assuming a retirement age of 60, I have another 32 years to go until retirement. Assuming a salary of £25000, inflation at 3% and salary increases in line with inflation, my final salary would be around £64500 per annum. My pension would then be £43000. Taking a life expectancy of 75, it's worth £645000. I reckon contributions towards it from now until retirement would be around £145000.

Would I not be likely to achieve a better return if I invested in equities through a SIPP? If they provided "normal" returns (somewhere around 8%) over the next 32 years by my calculations I would be better off, although my maths isn't up to working out by how much.

I've been contributing to my current pension for 10 years already so would have that as a lump sum to transfer over. It would remove the danger of being hit by further changes to my current plan and would mean that if I work past 60 I would actually see the benefit of making payments for longer.

Thoughts? Please go easy on me, I admit I don't know a great deal about how pensions work, it's all a long way off for me. I just thought I'd better at least give a bit of thought to something that's taking 10% from my wage every month rather than just blindly hand it over!

jamesd

It's great.

Easy part first, you gave a life expectancy of 75. It's currently 86.3 for males who are 65 years old today and is expected to get longer. A common mistake is to use life expectancy at birth figures instead of cohort life expectancy figures. Life expectancy at birth gives a shorter life collecting a pension because it includes all the people who die before they reach pensionable age. Cohort life expectancy gives the life expectancy for those who have already reached a particular age.

Assuming you're male the latest cohort life expectancy table for males says that half of men aged 28 in 2010 can expect to live for 58.4 more years and that those who retire at 68 in 2040 can expect to live for 21.7 more years, until they are 89.7. Those numbers don't add up because some of those who are 28 will die before they reach 68.

I used 68 there because that's the age at which you'll be able to get the state pensions.

So, instead of collecting that pension for the 15 years you calculated with retiring at 60 and dying at 75, the retiring at 68 case gives 21.7 more years and the retiring at 60 years case gives 28.8 years.

Now, collecting that final salary pension for say 29 (28.8) years makes it worth 29 * 0.66 * £25,000 = £478,500 in current value Pounds. Current value because it's all inflation-adjusted - the pension and I'm assuming your pay also. Your pay may increase due to promotions and in addition in general pay increases by 1-2% more than inflation so this understates the likely real value of the pension to you.

Again using current value Pounds you'd be paying in 32 years of £2,500, a total of £80,000. Ignoring the ten years at the lower rate.

There are plenty of other calculations you can make but the basic case is pay in £80,000 to get £478,500 of pension benefit.

That's a spectacularly good deal and it's so good in part because your employer is paying in far more than you, something around 20-25% of salary for a typical final salary pension scheme.

There's a different way to look at it, with investments you can take around 6% in income indefinitely, increasing with inflation. To get the £16,500 66% pension would take a lump sum of £275,000. That's closer to the actual investment target, after inflation, that you need to hit at age 60. Inflation at 3% for 32 years gives a multiplier of 2.58 so you'd need 2.58 * 257,000 = £663,060 to generate that income in non-adjusted terms. See whether your investments, not inflation adjusted, can hit that target. It'll be tough without the employer part.

ERICS_MUM

jamesd wrote: »

It's great.

Easy part first, you gave a life expectancy of 75. It's currently 86.3 for males who are 65 years old today and is expected to get longer. A common mistake is to use life expectancy at birth figures instead of cohort life expectancy figures. Life expectancy at birth gives a shorter life collecting a pension because it includes all the people who die before they reach pensionable age. Cohort life expectancy gives the life expectancy for those who have already reached a particular age.

Assuming you're male the latest cohort life expectancy table for males says that half of men aged 28 in 2010 can expect to live for 58.4 more years and that those who retire at 68 in 2040 can expect to live for 21.7 more years, until they are 89.7. Those numbers don't add up because some of those who are 28 will die before they reach 68.

I used 68 there because that's the age at which you'll be able to get the state pensions.

So, instead of collecting that pension for the 15 years you calculated with retiring at 60 and dying at 75, the retiring at 68 case gives 21.7 more years and the retiring at 60 years case gives 28.8 years.

Now, collecting that final salary pension for say 29 (28.8) years makes it worth 29 * 0.66 * £25,000 = £478,500 in current value Pounds. Current value because it's all inflation-adjusted - the pension and I'm assuming your pay also. Your pay may increase due to promotions and in addition in general pay increases by 1-2% more than inflation so this understates the likely real value of the pension to you.

Again using current value Pounds you'd be paying in 32 years of £2,500, a total of £80,000. Ignoring the ten years at the lower rate.

There are plenty of other calculations you can make but the basic case is pay in £80,000 to get £478,500 of pension benefit.

That's a spectacularly good deal and it's so good in part because your employer is paying in far more than you, something around 20-25% of salary for a typical final salary pension scheme.

There's a different way to look at it, with investments you can take around 6% in income indefinitely, increasing with inflation. To get the £16,500 66% pension would take a lump sum of £275,000. That's closer to the actual investment target, after inflation, that you need to hit at age 60. Inflation at 3% for 32 years gives a multiplier of 2.58 so you'd need 2.58 * 257,000 = £663,060 to generate that income in non-adjusted terms. See whether your investments, not inflation adjusted, can hit that target. It'll be tough without the employer part.

wow, what a good reply, even I understood it. I kept my final salary pension and it now looks like I made the right decision.

Linda

jamesd

The answer on final salary pensions where people are still making contributions, is almost always very easy: keep paying in. The chances of you being worse off are miniscule now the Pension Protection Fund is in place, provided the expected pension is within the £27,945 limit.

coloursixseven

Thanks for such a detailed response. I had used the wrong figures for life expectancy, I had used regional figures for someone my age, which as you've pointed out will also include those who die before 60. I've went back and had another look, and while I can't find the correct regional figures to use it seems like I'm looking at a life expectancy of somewhere between 80 and 87, which changes things somewhat.

I calculate that means the company pension is worth between £860000 and £1161000 on retirement, adjusted for inflation on both the contibutions made over the period and on my final salary

If I invested the same amount (allowing again for inflation on the contributions) and achieved a return of 8% over the period that would be worth around £750000.

I know this is based on a few assumptions (not least my assumption of a return of 8%), but in purely financial terms would holding equities worth £750000 at age 60 not be at least comparable to a company pension that is worth between £110000 and £411000 more, but that is paid to you over the following 20-27 years?

If/when I convince myself that my money's better in the company pension I really need to work out what it's actually worth to me because I think I've placed too high a value on it in the past when considering other jobs without a final salary pension.

Thanks again for your reply, and I take the points about the promotions and pay increases. My head hurts a bit now, I should have just stuck to the general rule of thumb that if your employer doesn't like something then it's good!

jamesd wrote: »

It's great.

Easy part first, you gave a life expectancy of 75. It's currently 86.3 for males who are 65 years old today and is expected to get longer. A common mistake is to use life expectancy at birth figures instead of cohort life expectancy figures. Life expectancy at birth gives a shorter life collecting a pension because it includes all the people who die before they reach pensionable age. Cohort life expectancy gives the life expectancy for those who have already reached a particular age.

Assuming you're male the latest cohort life expectancy table for males says that half of men aged 28 in 2010 can expect to live for 58.4 more years and that those who retire at 68 in 2040 can expect to live for 21.7 more years, until they are 89.7. Those numbers don't add up because some of those who are 28 will die before they reach 68.

I used 68 there because that's the age at which you'll be able to get the state pensions.

So, instead of collecting that pension for the 15 years you calculated with retiring at 60 and dying at 75, the retiring at 68 case gives 21.7 more years and the retiring at 60 years case gives 28.8 years.

Now, collecting that final salary pension for say 29 (28.8) years makes it worth 29 * 0.66 * £25,000 = £478,500 in current value Pounds. Current value because it's all inflation-adjusted - the pension and I'm assuming your pay also. Your pay may increase due to promotions and in addition in general pay increases by 1-2% more than inflation so this understates the likely real value of the pension to you.

Again using current value Pounds you'd be paying in 32 years of £2,500, a total of £80,000. Ignoring the ten years at the lower rate.

There are plenty of other calculations you can make but the basic case is pay in £80,000 to get £478,500 of pension benefit.

That's a spectacularly good deal and it's so good in part because your employer is paying in far more than you, something around 20-25% of salary for a typical final salary pension scheme.

There's a different way to look at it, with investments you can take around 6% in income indefinitely, increasing with inflation. To get the £16,500 66% pension would take a lump sum of £275,000. That's closer to the actual investment target, after inflation, that you need to hit at age 60. Inflation at 3% for 32 years gives a multiplier of 2.58 so you'd need 2.58 * 257,000 = £663,060 to generate that income in non-adjusted terms. See whether your investments, not inflation adjusted, can hit that target. It'll be tough without the employer part.

property.advert

Of course if you had equities of £750,000 then you would not be commuting it into an annuity !

If your salary is 25k and you are on 40/60 =16,667 and the 32 year multiplier at 3% is 2.58, then your pension is going to be 43k which would be a yield of 5.73% on your £750,000 portfolio.

Oh, and when you die, the insurance company does not keep your £750,000 !

If your pension is index linked then the numbers are significantly different.

I have not looked at pensions for many years but is there any mileage in thinking about what a transfer value would be were you to transfer just before retirement ? Surely if that value is £1m plus, then you would be better off doing that ?

marklv

coloursixseven wrote: »

I'm looking for some advice on my current situation. I'm currently in a company final salary pension that will pay 2/3 of final salary and my contributions have risen to 10% of salary.

I know that final salary plans are seen as excellent, secure pensions. I've never bothered to do the sums on it before, as I was sure that paying 5% of my salary out to get 66% of it back on retirement was a good idea, but the rise to 10% has me wondering if it's really that great.

Assuming a retirement age of 60, I have another 32 years to go until retirement. Assuming a salary of £25000, inflation at 3% and salary increases in line with inflation, my final salary would be around £64500 per annum. My pension would then be £43000. Taking a life expectancy of 75, it's worth £645000. I reckon contributions towards it from now until retirement would be around £145000.

Would I not be likely to achieve a better return if I invested in equities through a SIPP? If they provided "normal" returns (somewhere around 8%) over the next 32 years by my calculations I would be better off, although my maths isn't up to working out by how much.

I've been contributing to my current pension for 10 years already so would have that as a lump sum to transfer over. It would remove the danger of being hit by further changes to my current plan and would mean that if I work past 60 I would actually see the benefit of making payments for longer.

Thoughts? Please go easy on me, I admit I don't know a great deal about how pensions work, it's all a long way off for me. I just thought I'd better at least give a bit of thought to something that's taking 10% from my wage every month rather than just blindly hand it over!

I think you would be mad to give up a secure final salary pension, even with a 10% employee contribution rate. Investments on the stock market are very risky and volatile - there is no guarantee that you will see any growth, let alone the commonly forecasted growth rates of 7% a year or whatever the insurance company snake oil salespeople give out these days. Furthermore, as has already been mentioned, it's unlikely that someone your age will die at 75 - you are likely to live to around 85-90 years, maybe even longer. If your employer has a retirement age of 60 then your scheme is a very good one and a 10% employee contrbution rate not at all unreasonable.

MikeJones_2

And then there's the monetary value to be added of other potential contingent benefits such as:

- pension increases in payment
- spouse's / dependants' pensions / death benefits
- ill health provisions
- etc...

jamesd wrote: »

The chances of you being worse off are miniscule now the Pension Protection Fund is in place.

Unless you're one of the thousands of people like Danish Akhtar (see page 8).

The Pension Protection Fund is an excellent safety net for the majority of defined benefit scheme members that fall within its remit but is not the pensions panacea many people believe it to be...

Mike

(Not nit-picking at jamesd's excellent comments on this thread)

I work in the field of Pension Education and Pension Guidance in the UK. I am a member of the Specialist Pensions Forum as well as being a Voluntary Adviser for The Pensions Advisory Service. I work with scheme members, employers, trustees, scheme administrators and advisers on most things to do with employer sponsored pension schemes. The views expressed by me in this thread are my personal opinions. You should seek professional advice from an appropriately experienced and qualified adviser. I am not an IFA.

jamesd

MikeJones, yes, I should have specified getting a pension within the PPF limits. I've added an italicised mention of that.