Defined Contribution Vs Defined Benefit (USS Scheme)

dunroving

Having taught in both the UK and US, it is interesting to see UK university pensions move towards what is more the norm in the US, i.e., defined contribution schemes like TIAA-CREF, VALIC and the like; choose your own investments and live and die by the sword of your decisions.

I calculated that the 10 years (approximately) that I taught in the US has yielded a pension provision (invested with TIAA-CREF) that is approximately one third of my UK (USS) pension provision, also approximately 10 years. Of course if I drop down tomorrow, my USS pension disappears in a puff of smoke.

Colleagues who retired from UK HE institutions over the past 10 years are fond of bragging at how difficult it is to spend their gold-plated pensions. Where's my baseball bat when I need it?

In some US institutions you can choose between a (state-level) defined-benefits system and a defined-benefits system. A decent compromise with USS would be to markedly reduce the benefits of the DB system (so that it is fiscally feasible) and let people choose between that and a DC scheme - either choose a (reduced-benefit) guarantee or take your risks in the investment market.

Malthusian

Southend1 wrote: »

I think the willingness to contribute more to the pension is at least partly in recognition that we have suffered significant real terms pay cuts every year for ten years now.

Of which there will be more to come if university employees go from receiving 1/7th of their total pay packet as deferred income to 1/5th.

When you have part of your pay paid via active membership of a defined benefit pension, the employer must, by law, give you an above-inflation pay increase on that part of your pay every year. Your current entitlement has to be revalued in line with inflation, and you also accrue added years, so it's above inflation.

If the employer cannot afford to give you an above-inflation pay increase, then the above-inflation pay increase it must give you by law on your pension has to come from a real-terms pay cut.

As employees really, really don't like seeing their pay cut in nominal terms, the only option is often to stagger one year's worth of above-inflation pension increase via pay freezes over several years.

Having your salary paid as 4/5ths money in your pocket and 1/5th money in your pension means that it takes a bigger real terms pay cut in money in your pocket to pay for above-inflation increases to your pension (if it hasn't been met by increased university income), compared to 6/7ths and 1/6th.

kidmugsy

Southend1 wrote: »

I think the willingness to contribute more to the pension ...

Let me suggest a way to test the sincerity of their chatter. No doubt they've arranged that employees can contribute to their pensions by salary sacrifice. What do they do with the savings they get in avoiding Employer's National Insurance Contributions? If they promise that in future they'll chip that into DC pension contributions, or some alternative, then I might believe that they both wish, and can/could afford, to contribute more towards pensions. And if not, not.

It's a thought: the DC scheme with salary sacrifice and employer's NICs added would be a decent deal. Let's construct an estimate as follows. Our basis for comparison is an employee who currently pays an 8% contribution without use of salary sacrifice. With salary sacrifice kicking him back a reduction of NIC that will feel like roughly a 1% pay rise, he decides that he'll contribute 9% to his new DC pension, leaving him with approximately the same take-home pay. The first 4% earns the employer's contribution of 13.25 %. All 9% earns 13.8% extra by virtue of employer's NICS, and 13.8% of 9% equals 1.25% approx. Thus entering the employee's DC scheme is 9% + 1.25% + 13.25% of pay, = 23.5%. Plus, I suppose, the employee accrues the benefit of "the current subsidy of investment fees, and in service/death benefits for the DC scheme." I have no idea how to estimate that cost so I'll just assume that it will correct for any approximations or blunders in my sums: in other words, I'll ignore it.

Golly: when I was an academic the input was (if memory serves) 6.35% from me and 14% from my employer = 20.35%. So, broadly, 3.15 %age points extra could be going into the pension than in my day. It more than compensates for the extra subtraction from the employee's pay packet: 8% - 6.35% = 1.65%.

Of course a future government could sweep away the nonsense of salary sacrifice.

Southend1

kidmugsy wrote: »

Let me suggest a way to test the sincerity of their chatter. No doubt they've arranged that employees can contribute to their pensions by salary sacrifice. What do they do with the savings they get in avoiding Employer's National Insurance Contributions? If they promise that in future they'll chip that into DC pension contributions, or some alternative, then I might believe that they both wish, and can/could afford, to contribute more towards pensions. And if not, not.

It's a thought: the DC scheme with salary sacrifice and employer's NICs added would be a decent deal. Let's construct an estimate as follows. Our basis for comparison is an employee who currently pays an 8% contribution without use of salary sacrifice. With salary sacrifice kicking him back a reduction of NIC that will feel like roughly a 1% pay rise, he decides that he'll contribute 9% to his new DC pension, leaving him with approximately the same take-home pay. The first 4% earns the employer's contribution of 13.25 %. All 9% earns 13.8% extra by virtue of employer's NICS, and 13.8% of 9% equals 1.25% approx. Thus entering the employee's DC scheme is 9% + 1.25% + 13.25% of pay, = 23.5%. Plus, I suppose, the employee accrues the benefit of "the current subsidy of investment fees, and in service/death benefits for the DC scheme." I have no idea how to estimate that cost so I'll just assume that it will correct for any approximations or blunders in my sums: in other words, I'll ignore it.

Golly: when I was an academic the input was (if memory serves) 6.35% from me and 14% from my employer = 20.35%. So, broadly, 3.15 %age points extra could be going into the pension than in my day. It more than compensates for the extra subtraction from the employee's pay packet: 8% - 6.35% = 1.65%.

Of course a future government could sweep away the nonsense of salary sacrifice.

To my mind, 3.15% extra in a D.C. is nowhere near enough to compensate for the massive increase in risk to me as an individual that I won’t be able to retire with a decent income. I would much rather pay more now for a guaranteed income in retirement than rely on a vague hope that the markets will see me right. I suppose this might be different for those on higher incomes who can afford to take the risk but I’m on a shade over national average salary with little prospect of any significant increase in future.

Southend1

Puddylove wrote: »

I work for an HEI which is planning to offer around 24% of the workforce the 'opportunity' of redundancy 2018-19. I can't see them being willing to pay any more employer contributions.

And as for the USS - they are awful to deal with. I requesting a statement back in July 2017, was told they would be sent out by Nov. Contacted them again, and was told mine was full of errors so they'll send it by March.

8 months, just to get information.

Sorry to hear that, Puddylove. I’ve had two roles that were made redundant in the last 5 years but fortunately both times I was able to secure a suitable alternative. I feel your pain and wish you the best of luck.

kidmugsy

Southend1 wrote: »

To my mind, 3.15% extra in a D.C. is nowhere near enough to compensate for the massive increase in risk to me as an individual that I won’t be able to retire with a decent income.

Fair enough. But remember it's 3.15% more percentage points of pay going into the pension: it's a 15% increase in amount over what went in in my day. Moreover, it's usual to manage the money by taking more equity risk early in working life, and to reduce that risk as retirement approaches. So it may be a less "massive" increase in risk than you fear. Remember that DB funds carry risks too - consider Carillion.

I thought dunroving's suggestion was constructive: "A decent compromise with USS would be to markedly reduce the benefits of the DB system (so that it is fiscally feasible) and let people choose between that and a DC scheme - either choose a (reduced-benefit) guarantee or take your risks in the investment market."

Plus

There's an interesting call for evidence at the Work and Pensions Select Committee regarding Collective Defined Contribution schemes, which are enabled in the Pensions Schemes Act 2015.

The problem the USS is currently facing is that, to guarantee they can pay out on their future obligations, the Pensions Regulator forces them primarily to invest in bonds. This means they have almost zero returns. Meanwhile, some active members of the scheme have 30 or 40 years to go, when it's ludicrous to invest in bonds for that long.

The idea behind a CDC scheme is that risk is shared across members. In other words, you aren't told the pounds and pence you will get, but you'll get some proportion of the pot shared between all members. You are still exposed to investment risk, but you are not exposed to risk about how long you will live. It also means the scheme can invest in riskier assets, because there is enough money in the fund that they can pay out to current pensioners without having to pre-allocate a big chunk of bonds.

There are some problems, but it seems a plausible way forward. Apparently Royal Mail staff have voted to move to something like this approach.

kidmugsy

Plus wrote: »

Collective Defined Contribution schemes.

If the universities offered an employee the choice between dunroving's two options and Plus's one, people would be able to do far more to choose their pension scheme to suit their own circumstances and personalities.

System

Plus wrote: »

There's an interesting call for evidence at the Work and Pensions Select Committee regarding Collective Defined Contribution schemes, which are enabled in the Pensions Schemes Act 2015.

The problem the USS is currently facing is that, to guarantee they can pay out on their future obligations, the Pensions Regulator forces them primarily to invest in bonds. This means they have almost zero returns. Meanwhile, some active members of the scheme have 30 or 40 years to go, when it's ludicrous to invest in bonds for that long.

The idea behind a CDC scheme is that risk is shared across members. In other words, you aren't told the pounds and pence you will get, but you'll get some proportion of the pot shared between all members. You are still exposed to investment risk, but you are not exposed to risk about how long you will live. It also means the scheme can invest in riskier assets, because there is enough money in the fund that they can pay out to current pensioners without having to pre-allocate a big chunk of bonds.

There are some problems, but it seems a plausible way forward. Apparently Royal Mail staff have voted to move to something like this approach.

Where do you get the idea that they invest primarily in bonds?
https://www.uss.co.uk/how-uss-invests/the-fund/investments

Plus

Economic wrote: »

Where do you get the idea that they invest primarily in bonds?
https://www.uss.co.uk/how-uss-invests/the-fund/investments

As I understand it, the current deficit is calculated based on assuming the investment returns from bonds.
(I'm not clear if this is the whole fund or the liabilities to those receiving pensions)