Actuarial reduction

Freecall

I have looked at the result of actuarial reduction for taking early retirement from a public sector final salary scheme.

Although the arithmetic is far from straightforward, when you take into account the reduced contributions etc. the overall effect would appear to be financially neutral at a projected life expectancy of 79 years. In other words it makes no difference to the recipient when they take retirement, go early and get less but only in the proportion that the straightforward calculation would suggest.

Does anybody know if a) this sounds reasonable and b) private sector FS schemes would be similar?

I am aware of the obvious downside to this (that of a significant salary review or promotion which might be missed) but would like to understand the figures behind the process. I was expecting some sort of ‘penalty’ for being an early leaver.

jem16

Freecall wrote: »

I was expecting some sort of ‘penalty’ for being an early leaver.

The penalty is the actuarial reduction of around 5% pa. That and the loss of salary.

Whether it's worth it is up to you.

Freecall

jem16 wrote: »

The penalty is the actuarial reduction of around 5% pa. That and the loss of salary.

Whether it's worth it is up to you.

But that is my point, if you allow for the reduced payout (including the lower base for the index linking), the longer length of time you will be paid the pension, the value of contributions that will not be made in the remaining years and the investment shortfall or discounted cash flow of the payments then the whole thing appears to break even at 79 years of age whatever time you start from.

And yes, at ages near to NRD it does work out at about 5% per year.

My surprise is that there does not appear to be any further ‘punishment’ for taking it early.

The loss of salary is not relevant however as you would not have any labour input. You would have an opportunity benefit which would exactly cancel out any loss in this respect.

sandsy

Surely the whole idea behind the actuarial reduction is that it should be neutral, ie. the member making the choice doesn't lose out or gain and neither do the remaining scheme members. In particular, it shouldn't be possible for the member making the decision to select against the scheme.

BobQ

My neighbour recently retired from a public sector job - as a statistition- and he did a similar analysis to you and concluded much the same. He was also pleased that rather than his pensionable pay being frozen had he worked another year his pension would have increased by the index.

princeofpounds

The schemes don't exist to punish members who dont do the normal thing. They are mostly concerned to protect other members by making it more generous to you, but beyond that they aren't interested in disadvantaging anyone.

I'm no actuary, but I would have thought that breaking even at 79 is a little worse than you would get on average otherwise. Life expectancy is just above 80 I think, and as you are older your life expectancy is likely longer than average (because the average includes very early deaths). But it doesn't sound like its too bad a deal

hugheskevi

I'm no actuary, but I would have thought that breaking even at 79 is a little worse than you would get on average otherwise. Life expectancy is just above 80 I think,

More like 85 or a bit higher. Male aged 55 at the moment expects to live to 85-86 on average, male aged 64 to age 86. [cohort life expectancy, GB]

Does anybody know if a) this sounds reasonable and b) private sector FS schemes would be similar?

Occupational Pension Scheme Survey shows that in private sector, 1.2m active members have an actuarial deduction of 4% or more (for early retirement one year before Normal Pension age), whilst 0.5m have a reduction of 4% or less. (Table 5.9, OPSS 2010).

He was also pleased that rather than his pensionable pay being frozen had he worked another year his pension would have increased by the index.

A few of the public sector schemes use inflation-adjusted final salary calculated in a variety of ways, such that although salaries may be frozen, the final salary used for pension purposes increases by CPI, resulting in pensionable pay being above actual pay.

Freecall

Thanks hugheskevi that was exactly the kind of detail I was looking for.

Perhaps I should not be surprised that the system is ‘fair’, just my cynicism getting the better of me.

On the last point, many members of schemes have still not realised that this is the case and people retiring in the current year for example can get a very pleasant surprise. With a couple of years of pay freeze where inflation was around the 5% level people are finding that the notional salary for pension purposes is 10% higher that they expected. Happy days for some.