"Sweetener" for Deferring "Frozen" Final Salary Scheme

Tsmee

Hi,

Tried to post there and lost it, so sorry if this comes up twice.

I'm in a final scheme at work, but unfortunately it was "frozen" two years ago, so I'm still accruing 1/55th per year, but the salary it's based on is diminishing with inflation over time (I've got about 25 years till retirement). Plus, they're now moving to inflation linking at CPI up to 2.5%. The balance of my salary is eligible for a Definied Contiribution scheme where I pay 5% and they pay 7%. The DB one is also 5% cont.

We recently got a letter with the offer that we could defer our DB pension and move all our contributions to the new scheme. You could then put in up to 7% of your whole salary and they'd put in 9%.

I've put a few figures on a spreadsheet, assuming inflation at 2.5%, and this may be wrong, but to me it looks like I would be 8% better off not deferring. However, this does not take account of any returns from the DC contributions I would now be making on the frozen portion.

I've always been aware that a Final Salary Pension is incredibly valuable, but I'm not so sure now that it's frozen. But, call my a cynic, the extra company contribution "sweetener" makes me suspiscous. I'm a very cautious person, so my natural reaction is to keep things as they are. I'm also thinking it stops all my eggs being in one basket.

However, I'm wondering if I'm being too cautious.

Is it possible to work out what average return on the DC contributions would be necessesary to beat the current combined situation? I appreciate this might be a big ask!

Thanks for any thoughts,

Tsmee

JOHNGT

You say 'diminishing' with inflation. Do you not mean increasing in line with inflation (CPI up to 2.5%)? Or do you mean it is diminishing relative to your pay?

It would be possible to calculate but you'll need to make some assumptions about how much faster than CPI/2.5% that your pensionable salary will grow and how much CPI will be. The higher inflation is, the more the 2.5% cap will bite. You will also have to make assumptions about how fast CPI will grow, how fast your DC pot will grow (net of charges) and what rate you will get when you convert your fund into an annuity at retirement.

Your gut feel is probably right, any pension with a mix of DB in it, even if it is diminishing relative to your pay, is probably worth more than DC on the whole lot unless the DC contribution is substantially more, which it isn't in your case.

Tell me what the frozen salary is, what your pensionable salary is (i.e. the total including DB and DC), how fast you expect your pensionable pay to grow in future and I'll do some numbers for you (on which I will make some other assumptions).

Tsmee

Hi JohnGT,

Thanks for the reply.

Sorry, I think I mislead with the CPI thing. The frozen salary is definitely frozen, not increased at all. It's only if I leave the company or voluntarily defer that it increases by inflation up to CPI.

I really appreciate your offer to work out the actual figures, but I'm not sure I'm comfortable putting my salary on here, plus, I should say my situation is actually much more complicated because I've got AVCs which buy extra years (didn't want to muddy the waters), which makes me less likely to take up the offer to defer. I just thought there might be a formula to work out what was best in general and it would be handy for my colleagues. Although, to be honest, hardly anyone at work seems to care about their pension!

Tsmee

SallyG

Is it legal for a final salary/defined benefit preserved/frozen pension not to be index-linked to RPI/CPI - capped possibly at a max% - but increased at the point of being taken into payment by some agreed amount to make up for inflation?
Or is it simply down to trustees/scheme rules to confer or withdraw index-linking?

Tsmee

The way it was explained to us when it was frozen was that we had a contractual right to a final salary pension, which they could not unilaterally change, but we had no automatic right to a pay rise over the years, including rises to keep pace with inflation.

Bear in mind that it's still in operation: I'm still accruing an extra 1/55th every year, it's just 1/55th of an ever diminishing amount. If I defered, through leaving work or voluntarily switching it all over to the DC scheme, then it would then increase by CPI, but obviously I'd accrue no more years.

Not chuffed about it, but nothing I can do.

JOHNGT

OK Tsmee, understand your reluctance.

Legally, they can do this as long as your contract of employment doesn't stop it - so it sounds like they have done their homework, Even so, employers with DB schemes in the contract have effectively ripped up the contract and replaced with new one (subject to the required 'consultation').

Even although your DB is diminishing, it will be worth around 20% (at your age - 25 yrs to go) of the frozen DB salary. This value increases with age such that a DB scheme is worth about 35% of pay in your mid-50s. So, if you blend the 20% with 12% on the excess then this will give you an average rate across your whole salary. For example, if you the frozen salary were £15,000 (@20%) and the excess salary £5,000 (@12%), the blended rate would be 18%. Increase the DB worth at about 1% a year i.e. next year it is worth 21%, the year after 22% and so on.

You can then then compare the annual blended rate to the 16% if you were 100% DC.

And of course the DB/DC option only costs you 5% whereas the DC only costs you 7%.

Loughton_Monkey

Tsmee wrote: »

We recently got a letter with the offer that we could defer our DB pension and move all our contributions to the new scheme. You could then put in up to 7% of your whole salary and they'd put in 9%.

I take this to mean they would effectively throw the whole DB 'value' into the money purchase scheme rather than leave those rights 'frozen' and simply put all contributions into DC?

If I'm right, the thing to watch is the value they put on your DB pension rights to date. Remember that such a value is simply a 'calculation' containing a very big bag of assumptions. To be cynical, they could 'value' this using cautious assumptions (for themselves) and come up with less than half the 'true' value if they wanted.

[As a true example, I had a FS scheme that became fully 'deferred' 16 years before I took it. By the time I took it, the annual growth was 11% - far, far, more than it would have grown in 'good' funds. And thus extremely 'undervalued' at the time I left.]