Should I opt out of my DB scheme?

Simonwantssomehelp

I would appreciate comments on my pension position.

Firstly, I’m very aware that I’m in an extremely fortunate position. I’m in an excellent DB pension scheme and the “problems” described below are very nice problems to have! I wanted to say that to avoid any unnecessary comments.

Secondly, I have posted on MSE previously but as I’m revealing some personal information I have created a new ID.

• I’m in a final salary DB scheme with normal retirement age of 60 and I’m currently 56.
• I also have AVCs through my employer’s scheme but I stopped contributing some time ago as I had exceeded the LTA.
• I have Individual Protection giving an LTA of £1.5m.
• Current value of plan (DB plus AVCs) is around £1.7m.
• I’m a high earner and exceed the 150k annual input limit for tapering (after adding DB input calculation). I expect my salary to remain unchanged (no inflationary increases) until retirement. My marginal tax rate is 40%.
• Due to the (standard) way my DB plan operates, I have exceeded the annual input limit in 2017/18 by about 30k (after using the small remaining balance available to carry forward). I have to pay the tax liability on this but fortunately my DB scheme operates a “scheme pays” option so I will use this and accept the related reduction in pension. This has the benefit of reducing my LTA liability.
• In the current year I expect to exceed the input limit again and the value will continue to increase so increasing the LTA liability.
• I do not wish to stop work now and would prefer not to take an early pension.
• The decision I have to take is whether to opt out of the DB Pension Scheme. My contribution is 5%.

I’m happy to pay for an IFA if appropriate but I think this may be a “no-brainer” and I should immediately opt out of the scheme. This post is to see whether others agree.

Comments welcome, including any other options I have not considered. Thanks in advance. Do ask for any other relevant facts I have omitted.

kidmugsy

Your 5% contribution: what does it achieve in terms of increasing the value of the future annual pension?

If you did opt out would any alternative compensation from your employer be arranged?

I suspect that it makes sense to continue contributing because it is likely that you'll gain more by means of the employer's notional contribution than you'll lose by reduction of the future pension by means of "scheme pays" and whatever penalty you eventually have to pay for having been a Bad Boy.

Also I might hang on in hopes of the madness of LTA being relaxed at some point.

HappyHarry

Simonwantssomehelp wrote: »

I would appreciate comments on my pension position.

Firstly, I’m very aware that I’m in an extremely fortunate position. I’m in an excellent DB pension scheme and the “problems” described below are very nice problems to have! I wanted to say that to avoid any unnecessary comments.

Secondly, I have posted on MSE previously but as I’m revealing some personal information I have created a new ID.

• I’m in a final salary DB scheme with normal retirement age of 60 and I’m currently 56.
• I also have AVCs through my employer’s scheme but I stopped contributing some time ago as I had exceeded the LTA.
• I have Individual Protection giving an LTA of £1.5m.
• Current value of plan (DB plus AVCs) is around £1.7m.
• I’m a high earner and exceed the 150k annual input limit for tapering (after adding DB input calculation). I expect my salary to remain unchanged (no inflationary increases) until retirement. My marginal tax rate is 40%.
• Due to the (standard) way my DB plan operates, I have exceeded the annual input limit in 2017/18 by about 30k (after using the small remaining balance available to carry forward). I have to pay the tax liability on this but fortunately my DB scheme operates a “scheme pays” option so I will use this and accept the related reduction in pension. This has the benefit of reducing my LTA liability.
• In the current year I expect to exceed the input limit again and the value will continue to increase so increasing the LTA liability.
• I do not wish to stop work now and would prefer not to take an early pension.
• The decision I have to take is whether to opt out of the DB Pension Scheme. My contribution is 5%.

I’m happy to pay for an IFA if appropriate but I think this may be a “no-brainer” and I should immediately opt out of the scheme. This post is to see whether others agree.

Comments welcome, including any other options I have not considered. Thanks in advance. Do ask for any other relevant facts I have omitted.

I don't think this is a "no-brainer" at all.

You contribute 5% of your salary, and in return, your pension will increase due to the length of time you have spent in the scheme.

The cost to you is 5% of your salary for 4 years. As you are a 40% taxpayer (are you sure?) then the net cost to you is 3% of your salary for 4 years.

The benefit to you is your pension every year will be higher due to your length of membership.

The complicated bit is the Annual Allowance charge will be deducted from your pension, reducing your final pension, and the Lifetime Allowance charge will be taken from your pension at retirement, also reducing your final pension.

You need to carry out a calculation taking into account the following;
a) Net cost to your income for 4 years
b) Increase in final pension due to length of membership less impact of Annual Allowance charge less impact of increased Lifetime Allowance charge.

Then, multiply (b) above by the number of years you expect to live, and compare it to (a) above.

n.b. Don't forget to take inflation into account, as this will affect your final pension amount when it is paid and increase your final pension in retirement.

Triumph13

As a rough estimate you are going to lose 40% of your accrual to AA charge and then 55% of what's left to LTA charge - leaving you with 27% of your advertised accrual rate. I can understand that feels painful, but looked at purely as a stand alone decision it still sounds like something that would be well worth taking.
If it's a 60ths scheme, that would mean £50 of contribution gets you £4.50 a year of pension which is still a fantastic deal (tax ignored as presumably you will be an HRT payer in retirement).

Simonwantssomehelp

Thank you for the replies so far which have been extremely helpful.

In my effort to present my position concisely in recognition of people kindly giving up their time to read and/or reply I realise I omitted a crucial piece of information.

• If I opt out of the fund my employer will pay me a cash allowance of 18% of pensionable salary (about 17% of gross pay) subject to normal tax and NI deductions, of course.

In response to other questions above:

• Yes, I'm definitely way below the 45% incremental tax rate; it's only the pension input which pushes me over the 150k tapering level. If I opt out and take the cash allowance I would be almost spot on the 45% rate threshold. (But what knows what Monday's budget may change?!).

• Accrual rate is 1/60th - I think that answers "what does my 5% contribution achieve".

• I will be a higher rate tax payer in retirement. Under current legislation 40%.

Thanks again.

Aegis

Very difficult to say for sure without some in depth calculations, but the 17% extra salary coupled with the 5% that you no longer have to pay in is likely to be quite appealing compared to the pension benefits net of annual allowance and lifetime allowance charges, which will need to take into account the scheme commutation rate at the point you intend to retire (i.e. the rate at which they will convert scheme income into a lump sum, which can range between very generous and borderline punitive).



It's possible that it will boil down to a toss-up and become essentially a judgement call as to what feels most comfortable, which may vary depending on how long you expect (or hope) to live.



A cash flow forecast might help contextualise the decision, putting a value on likely benefits achieved from the scheme vs a notional pot of cash that you set aside from the increase in salary. You can do this yourself in Excel or get a financial planner to put one together for you.

Berkshire_Beancounter

One other aspect which you didn't mention, but I raise just in case: are there any legacy benefits in your pension scheme on redundancy? And if so is there any likelihood you may get made redundant before the age of 60?

The company I used to work for had some pretty generous enhancements such that if you were made redundant after the age of 50, you could get a pension which wasn't subject to actuarial reductions as it would have been if you retired voluntarily. It was also paid over the age of 50, not 55.

When the company consulted on increasing pension scheme contributions, some of my colleagues considered opting out of the scheme (especially if they were near to, or over, the LTA) but the redundancy enhancements would have been lost if someone had opted out. I regarded the additional cost and potential additional tax as an 'insurance premium' that was worth it, given the generosity of the redundancy enhancements.

It may well not be relevant to you, but I mention it as another factor to consider on the off chance your scheme is as generous as mine was!

kidmugsy

Berkshire_Beancounter wrote: »

One other aspect which you didn't mention, but I raise just in case: are there any legacy benefits in your pension scheme on redundancy?

What a strong point. How about any other non-pension benefits from the DB scheme e.g. life insurance?

@ OP: come to that, should one also weigh up the advantages and disadvantages for your widow of extra widow's DB pension versus access to the capital from the employer's cash allowance? (Is there any chance of using the latter to boost your wife's pension?)

Berkshire_Beancounter

kidmugsy wrote: »

How about any other non-pension benefits from the DB scheme e.g. life insurance?

That's an excellent point which had slipped my mind in my original post. Death in service benefits can be significant (e.g. 4 x salary payable as a lump sum), children's pensions, etc. Worth checking all these other aspects too before coming to a final decision.

Triumph13

Berkshire_Beancounter wrote: »

That's an excellent point which had slipped my mind in my original post. Death in service benefits can be significant (e.g. 4 x salary payable as a lump sum), children's pensions, etc. Worth checking all these other aspects too before coming to a final decision.

The 17% cash equivalent changes everything. No way is it worth spending £220 to get £4.50 a year of pension. Staying in only makes sense if there are the kind of 'extras' that people have suggested.

Simonwantssomehelp

Some really good points above, thanks. I'm particularly interested in the redundancy point as my company does indeed provide "pension augmentation" for over 55s who are made redundant. I expect it is a similar arrangement to that described above. There is no actuarial reduction for retirement before 60 (I'm 56). I don't think I'm at imminent risk but we are undergoing a cost cutting programme so there is always the possibility of either voluntary or compulsory severance/redundancy.

I've had a look at the details of the opt out arrangement. Here is the relevant section:

How can I tell if it makes sense to opt out and take cash?

This is a difficult question to answer as it depends heavily on your personal and future circumstances.

As an example, if your pensionable salary was £120,000 then each year you would earn additional pension of £2,000 (1/60th X £120,000). After a 25% LTA charge and income tax (assume 40%), this could provide extra annual net income of £900.


Instead you could receive a cash allowance of £21,600 (£120,000 X 18%) plus you would not have to pay pension contributions of £6,000 (£120,000 X 5%) making a total of £27,600 or net £16,008 (asuuming 40% tax and 2% NI).


So, at a simple level, ignoring any increases to your pension, it would take just under 18 years after retirement to match the cash allowance.


But there are several variables whcih make this comparison more difficult in practice:

Because it is a final salary scheme, the pension grows as pensionable salary grows

[unlikely to be relevant to me]

If you are planning to retire early, any reduction for early payment reduces the value of your pension for LTA purposes [Could be relevant in due course, I guess. Using "scheme pays" for the AA tax liability would also reduce the value for LTA]

When in payment, pension will be increased by inflation

Pension will be payable until death

Cash allowance could be invested until retirement and gain in value

Funding the LTA charge from pension may produce a different reduction than 25% because of the conversion factor used by the fund

If you opt out you would not received the death in service or ill health benefits available to contributing members of the fund. However, the employer has decided to "top up" life cover to the level that would have been paid by the fund which is four times pensionable salary. In all other respects such as ill health retirement you will receive the benefits of a deferred pensioner which includes dependants' benefits.

<Scratches head> I'm still unsure what to do but maybe edging towards opting out.

Further comments welcome, of course!