Teachers pension scheme top up, is it value?

chucknorris

As I recently started work as a university lecturer I have access to a decent pension scheme which offers the option to buy additional pension top ups. I could buy an additional £5,400 of pension top up for a net cost of £40,066 (£66,744 gross). I carried out a simple spreadsheet appraisal based upon simply putting that cash into a savings account (paying 5% now and going up eventually to 6.5%, when rates return to normal). I chose a savings account as it's easy to assess, obviously there would be other options too, but it's more about testing the value of the pension option at the moment than identifying what the exact alternative is. The break even point when my pension catches up with the savings account is when I am 87 years old (I am 53 now and probably plan to retire about 65). I did allow for the fact that I could (and would) take a 25% tax free lump sum on retirement.

That to me just looked ok, but nothing special (after all I may not reach 87 and if I do It might be not much beyond that), but perhaps I am missing something? If I am someone please enlighten me. Because we are going to have plenty of money anyway in our retirement, insurance against pension poverty is not an issue to us. So I am struggling to see the value in buying this additional pension top up, it doesn't seem to stand out as an exceptional investment to me. But perhaps I am wrong, I am willing to listen if anyone has any valid contribution.

hugheskevi

Another way of looking at the value is to compare and contrast to annuity rates.

Using Additional Pension, you get an annuity rate of 5.73% for a male aged 65 with CPI escalation and no partner benefits (calculate this by looking at the lump sum required for a man aged 64 and 364 days old).

This compares to RPI-linked annuity rates of approximately 4.4% available commercially for the same man.

So on that basis it is very good value. But the value reduces the further away from retirement you are in all the calculations I have done. And the lump sum has a commutation rate of 12:1 which is awful.

To me, there are two questions here (1) Do you want to save more in a pension then (2) If you do want to save in a pension, should it be a personal pension or additional years.

I can't recall if the Additional Pension has to be commenced at the same time as main scheme benefits - if it does, that is another potentially serious drawback.

Also remember the withdrawal of the higher Personal Allowance after State Pension age which starts at £24,000 which gives you a marginal tax rate of 30%.

And if you have a good pension already (£15-20K+ p/a), Flexible Drawdown might be attractive to you, which wouldn't be possible under Additional Pension and would make a Personal Pension well worth considering.

Zelazny

Is the pension top up a fixed amount of £5,400 on retirement, or does it rise in line with inflation/salary? Could make a big difference on the return

chucknorris

Zelazny wrote: »

Is the pension top up a fixed amount of £5,400 on retirement, or does it rise in line with inflation/salary? Could make a big difference on the return

It does rise but in my appraisal I assumed an inflation growth of 2.5% PA

chucknorris

hugheskevi wrote: »

Another way of looking at the value is to compare and contrast to annuity rates.

Using Additional Pension, you get an annuity rate of 5.73% for a male aged 65 with CPI escalation and no partner benefits (calculate this by looking at the lump sum required for a man aged 64 and 364 days old).

This compares to RPI-linked annuity rates of approximately 4.4% available commercially for the same man.

So on that basis it is very good value. But the value reduces the further away from retirement you are in all the calculations I have done. And the lump sum has a commutation rate of 12:1 which is awful.

To me, there are two questions here (1) Do you want to save more in a pension then (2) If you do want to save in a pension, should it be a personal pension or additional years.

I can't recall if the Additional Pension has to be commenced at the same time as main scheme benefits - if it does, that is another potentially serious drawback.

Also remember the withdrawal of the higher Personal Allowance after State Pension age which starts at £24,000 which gives you a marginal tax rate of 30%.

And if you have a good pension already (£15-20K+ p/a), Flexible Drawdown might be attractive to you, which wouldn't be possible under Additional Pension and would make a Personal Pension well worth considering.

But comparing it to annuity rates isn't relevant, what I am trying to find out is whether it is a good investment (not if it better or worse that annuities). I don't feel the need to invest in my pension I merely want to explore if it is a better investment than anything outside of a pension, if it is good value and I am overlooking something then I am equally happy to top my pension up, but from an 'investment' viewpoint rather than buying additional pension as some sort of insurance against pension poverty.

kidmugsy

chucknorris wrote: »

It does rise but in my appraisal I assumed an inflation growth of 2.5% PA

Haven't you just assumed-away the big advantage of an index-linked pension viz protection against unexpected and dramatic lurches upward in inflation rates? I mean, if inflation were to be a steady 2.5% p.a. I'd happily settle for a flat annuity or a steadyish income withdrawal from a Personal Pension of some kind. So I'd guess that if your other pensions are going to have inflation-protection as good as that of the Teachers' scheme, I can see why you are not much interested in topping up. But if only the Teachers' scheme offers robust protection versus inflation, perhaps the top up is worth consideration.

chucknorris

kidmugsy wrote: »

Haven't you just assumed-away the big advantage of an index-linked pension viz protection against unexpected and dramatic lurches upward in inflation rates? I mean, if inflation were to be a steady 2.5% p.a. I'd happily settle for a flat annuity or a steadyish income withdrawal from a Personal Pension of some kind. So I'd guess that if your other pensions are going to have inflation-protection as good as that of the Teachers' scheme, I can see why you are not much interested in topping up. But if only the Teachers' scheme offers robust protection versus inflation, perhaps the top up is worth consideration.

You've probably got a valid point there.

ButI think I have spotted another really good reason to buy more pension top up. What I think I should do is buy enough pension top up to reach 20k of guaranteed pension income. Then take out a seperate SIPPS pension and use flexible income drawdown to withdraw all of it when I retire, this means that I can claim 40% tax back on everything I invest in the SIPPS and yet draw it all out when I retire (paying 40% tax on 75% of it of course). But that seems like a great deal to me.

hugheskevi

Reason I mentioned annuities was that this gives you a mark-to-market comparison. Flat annuities have a load factor of about 10%, inflation linked ones about 25%. So if the implied annuity rate of Additional Pension is 25% ahead of an escalating annuity then the return is okay in terms of expected returns from gilts and bonds, and you effectively get free insurance.

Suffice to say, all calculations I have ever done involving Additional Pension show that it is okay, but nothing to write home about, particularly for younger members. Its value predominantly lies in its certainty, which it sounds like you don't need.

Other things...be careful about Annual Allowance and Lifetime Limits.

Buying £5,400 of Additional Pension along with the usual pension accrual will count as an awful lot of pension contributions. With the 3 year look-back for Annual Allowance you might be okay however but definately something to be aware of (also, as I understand it £5,400 of Additional Pension would count as a £86,400 contribution regardless of how much it actually cost you).

Based on your other post, it would seem you must be in danger of running up against Lifetime Limit issues. Presumably you have sorted out protection of one form or another.

Sobraon

Lets work it backwards (but back of fag packet type calcs), assuming retirement at 65 , life expectancy 22 years, 50% final salary pension.

If you had retired in 1989 then: Average property price across UK was: £60000, Average price for a loaf of bread was: 48p, Average price for a pint of beer was: 96p, Average price for a litre of petrol was: 38p

Average salary for a lecturer was about £16000 (12k national average wage).

CPI since 1989 gives approx 1.7 times increase (although this is difficult to pin down)

Therefore full pension retiring in 1989 = 8K, with no index linking this would still be 8K, with CPI indexing would be about 13.6K

Still happy with a flat "annuity"?

kidmugsy

"Still happy with a flat "annuity"?"

Inserting age 65, 65; 50% widow's benefit; no guarantee, and my own postcode into an annuity calculator I find that an RPI-linked annuity would currently be about 54% of a level annuity for £100000. To fag-packet accuracy I'll assume that that same ratio obtained back then, and calculate £13.6 x 0.54 = £7.4, so the index-linked annuity still hasn't caught up with the level one of £8k.
So, yes, still happy.