Final Salary v. Career Average Pension Scheme

akay

I am a low earner but contribute to a final salary scheme (7 yrs). I may reduce my hours in future, therefore would I be better off changing to the career average scheme also on offer.

Through research I am led to believe final salary scheme is better for the high wage earners.
Also can anyone point out the major differences between the two types of schemes.

Thoroughly confused, would be grateful for experienced thoughts, thank you

MoneySaverLog

I guess that if you're on a final salary scheme they look at the average of the last 3 years (where you've had pay rises up to this point :-) ) before retirement which would be higher for most people in full time employment than someone's career lifetime average.

As these lifetime averages are a new thing, I'm of the opinion anything new is coming in as a worse option for the individual and better for the company. I'd stick with final salary given a choice in that case.

Shimrod

Your starting point for this is to check how the pension rules defines 'final salary'. It may be calculated as MoneySaverLog says, but it can also be something like 'best 3 salaries out of the last 10 years'.

MoneySaverLog

it probably makes sense as final salary if you're a low earner say £12K now with a long career ahead of you you could possibly say end up with £50K in the final 3 years.

You can see what averaging will do to what would happen to your pension in this scenario.

PS I know mine is the average of the last 3 years before retirement.

hyubh

akay wrote: »

I am a low earner but contribute to a final salary scheme (7 yrs). I may reduce my hours in future, therefore would I be better off changing to the career average scheme also on offer.

Depends on the relative accrual rates. In the case of the LGPS which will be moving from a final salary to a career average basis soon, for example, it will actually be better for many low paid workers because the proposed accrual rate is very generous (1/49th from 1/60th, no automatic lump sum in either case).

Andy_L

hyubh wrote: »

it will actually be better for many low paid workers because the proposed accrual rate is very generous (1/49th from 1/60th, no automatic lump sum in either case).

The accrual rate is better, although only by about 0.3%, however the revaluation rate means low paid workers are only going to be better of if their payrises consistintly stay under CPI + 0.3% which would take some effort.

Zelazny

Andy_L wrote: »

The accrual rate is better, although only by about 0.3%, however the revaluation rate means low paid workers are only going to be better of if their payrises consistintly stay under CPI + 0.3% which would take some effort.

The difference cannot be viewed properly just by taking one accrual rate from the other (which is where I assume you get your 0.3%). The 1/49ths will give a pension 22% higher than the 1/60ths will. Wage increases of higher than inflation will erode this, but the exact amount will depend on the time the benefits are accrued over.

For example, comparing the 1/49th CARE against a 1/60th Final Salary over 5 years, you'd need annual pay rises of about 11% over Inflation for the two to be equivalent. For pay rises of less than 11% over Inflation the Career Average scheme is better.

Over 10 years, the break even point comes at about 5% over inflation.

Over 20 years, it's about 2.3% over inflation.

Over 30 years, it's about 1.5% over inflation.

Over 40 years, it's about 1.1% over inflation.

So consider how long you think you'll be part of the scheme, and how much you think your annual pay rise will be in excess of inflation - then choose accordingly.

For the record, I only have the option of CARE, but it's at about 1/45th, so I don't think there'll be much difference to being in a 1/60th final salary scheme (with my expected salary increases and expected length of service).

akay

Really learnt a lot- thankyou. Have checked further, the accrual rate for both Final Salary Scheme and Career Average Scheme are the same at 1/60th. I am a low earner (presently under 10k)

Final salary scheme has final pensionable earnings as best annual earnings in any one of the last five years before retirement.

Therefore if I am going to reduce my hours, consequently my annual earnings around retirement will be much lower than now- will I be better off changing to the career average ??

Also would I be right in thinking that career average means when they calculate pensionable earnings, they would take average annual earnings which are full time earnings now and much lower when I reduce my hours in my later years.
I have twelve years to go to retirement age and wish to reduce my hours and maximise my pension, hence my question about if career average is suitable for my scenario.

hyubh

akay wrote: »

Have checked further, the accrual rate for both Final Salary Scheme and Career Average Scheme are the same at 1/60th.

Other things being equal, I'd prefer the final salary version then, even if the employee contribution rate was higher. On the other hand, the career average scheme will still be a defined benefit one (one implication being the investment risk will lie with the employer rather than the employee), so pretty good nonetheless.

I have twelve years to go to retirement age and wish to reduce my hours and maximise my pension, hence my question about if career average is suitable for my scenario.

In the LGPS the 'salary' used is the whole-time equivalent salary, with the service being pro-rated if a part time. E.g., if a part timer was in the scheme for 20 years, working 50% full time throughout and leaving on an actual salary of £15,000, then the pension benefits would be calculated on the basis of 10 years membership and a final salary of £30,000. While it's perfectly possible your scheme uses calendar service and actual pay instead, you should definitely double check.