What would you offer?

Perelandra

Disclaimer: Please treat the below purely as a hypothetical question, for discussion only. I am not in the situation described below, I do not know anyone in this situation and have no intent of proposing this in practice!

A relative of mine is currently enrolled in a defined benefit, final salary scheme. It pays a pension that pays 1/60th of final salary for every year she has paid in to it, on her death her spouse would receive half of this. It is index-linked.

She is currently aged 45, and has a normal retirement age of 60. I am 5 years younger.

At present, she earns £45,000, and pays 10% of this as contributions. Historically, excluding promotions, she has seen a 0.5% p.a. rise in her real (inflation adjusted) pay.

However, she is considering leaving the scheme, for short-term cash reasons, with the intent to rejoin in 5 years time.

I am considering making her an offer to "buy" those five missing years from her. i.e., ask her to continue paying into the pension, then pay her directly a sum of money to buy the "right" to 5 years worth of her pension when she retires.

She will benefit because:
The payment I make will be higher than the 10% she is currently paying in, and
If I die before she does, she will have the benefit of "my" 5 years worth of her pension.

I will benefit because:
I believe that the price of a guaranteed income is low, compared with buying that same benefit on the open market.

I am taking on additional risk of:
She might die before me.
She might default on our agreement (although I consider this risk to be negligible, for discussion purposes).

Ethics aside- please remember that this is purely an academic question- how much should I offer her per year to buy these years of her pension?

greenglide

You could offer to marry / enter a civil partnership with her to protect bereavement rights!

Normally you can't simply increase contributions to a DB scheme.

Many DB schemes won't let you rejoin.

PensionTech

From an actuarial perspective you would have to be able to quantify:

• the risk of default
• the cost of administering/enforcing (would you propose drawing up a financial contract? if so, would you need to consider solicitors' costs?)
• the tax that she would be paying on the income
• the internal rates of return for each cashflow
• the expected statistical distribution of her (and your) life expectancy

In short I don't think anyone here will be able to give you an accurate answer for how much you should pay for the benefit. More likely it would be a case of deciding how much it is worth to you, possibly considering the cost of buying such a benefit (i.e. a deferred annuity) on the open market.

I should also point out that pension legislation prohibits this kind of arrangement, although there would probably be a way to draw up a contract around it.

I have to ask: why are you asking this question? You say "for discussion only" but I am struggling to understand the academic value.

Perelandra

greenglide wrote: »

You could offer to marry / enter a civil partnership with her to protect bereavement rights!

Normally you can't simply increase contributions to a DB scheme.

Many DB schemes won't let you rejoin.

Hopefully she's not too close a relative then.

grey_gym_sock

Perelandra wrote: »

Hopefully she's not too close a relative then.

ah, so it's your sister?

(your hypothetical sister, i mean.)

Perelandra

PensionTech wrote: »

I have to ask: why are you asking this question? You say "for discussion only" but I am struggling to understand the academic value.

Thank you for your post- I'll respond to this part first and consider the other part later.

It's of interest to me, firstly to see the assumptions that people would make for that cashflow, and to see from a risk-neutral point of view, where the breakeven point would be for investing, versus saving into a DB scheme.

Of more interest, though, would be to see how other people would view that risk- as you suggest, it comes down to what it would be worth to me. I'm sure that the answer I would have would be different from the answer to other people- and I'd be interested in seeing this. I tend to learn what's important by reading other people's views, and digesting/distilling what they say.

It really is "for discussion only"- it serves no practical purpose for me.

Perelandra

grey_gym_sock wrote: »

ah, so it's your sister?

(your hypothetical sister, i mean.)

Hrm... well the age gap would rule out mother or daughter....

... cousin?

PensionTech

If you're just looking at the break-even point for contributions to a DB scheme versus investing, then your question is extraordinarily overcomplicated!

Triumph13

From a purely hypothetical viewpoint, as you are taking on all the risk and she is taking none an equitable arrangement would probably have you paying not a whole lot more than the value of the contributions. Perhaps an arrangement where you paid the contributions and she paid you 90% of those 5 years' pension might be the right kind of number - the important thing would be to be sure that everyone felt the deal was 'fair' so as to minimise the risk of default and/or family acrimony.

kidmugsy

Ask on a French forum - they are used to the private sale and purchase of annuities. Maybe they'll even have a spreadsheet, the well known answer to every problem that mankind faces.

RichandJ

kidmugsy wrote: »

Ask on a French forum - they are used to the private sale and purchase of annuities. Maybe they'll even have a spreadsheet, the well known answer to every problem that mankind faces.

Nah, I still can't get mine to make a decent cup of coffee.