Benefit value of Defined Benefit pension

Pete150

Hi,

I have a question on pension values I hope someone can help with please.

I’m in the fortunate position of still having a defined benefit pension due to having been at my current employer for quite a few years.

The scheme closed to new members but is still available to existing members, albeit now on less good terms than it used to be (career average rather than final salary, additional details below).

My question is - how much is this worth to me as a benefit over a typical defined contribution scheme? Or in other words:

1. If I was to move employers and lose this as a benefit going forwards, how much of a pay rise would I need to get to be roughly break even as a total package, and

2. what level of contribution would need to be made in to a defined contribution scheme to get a similar level of pension, assuming typical levels of stock market growth longer term?

I recognise this will not be an exact science as I would be carrying stock market risks rather than the pension scheme, but a general ball park estimate would be useful.

Background as follows:

Pension Scheme was final salary until Apr 2017 when it moved to a career average scheme for current members, and closed to new members who are now enrolled on a defined contribution scheme.

I contribute 11% of salary via a salary sacrifice payment. Each year of contribution adds 1/60th of salary to the pension.
I have a little over 25 yrs to go until I reach retirement age.
I also have the option of a reduced contribution of 7% in return for 1/70th salary, though not used this option so far.

Thanks
Pete

Seabee42

Hmm There is nothing inherently better in a defined benefit scheme than a defined contribution scheme. The older you are the more valuable a defined benefit is because the years of investment to provide that benefit are less. Most defined benefit schemes cross subsidise so the employer pays one rate for all employees but the older employees are costing more.


Now that being said most defined contribution schemes the employer is paying in very little (say around 5%), given the average contribution to a 1/60th defined benefit scheme is likely to be around 25% there is a big discrepancy.


Then there is the risk element. Clearly (ignoring employer risk) the defined benefit is guaranteed with money purchase you get the benefit and cost of good and bad investment return.


The important thing therefore to me, is not the type of scheme but how much is being paid in.

crv1963

Good to have a DB scheme pension. I wouldn't reduce to the 7% 1/70 option.

I don't know how to work out exactly how much extra you need to balance things up if you change jobs but, I was advised that if I left my scheme I would need to earn between 25% and 35% extra and contribute at least half of my take home pay into a DC pension to get anywhere near as good a pension in retirement.

So unless there are other compelling reasons to change roles I would stick with what you do now.

MarkCarnage

Hmm There is nothing inherently better in a defined benefit scheme than a defined contribution scheme.

Beg to differ...if there wasn't anything better for the employee and hence more costly for the employer, then they wouldn't be getting closed down. The inherently better things are the removal of market risk and longevity risk. Clearly there are good DC schemes and bad DB ones, but as a generalisation, DB has got to be inherently better.

Responding to the original questions, the likely cost of replacing a DB scheme with DC is difficult to quantify, partly because of challenges in valuing the market risk and longevity risk assumed. It's also likely that at current relative asset class valuations that there is a very good case that a more equity orientated asset allocation will prove to be better in DC. As a guesstimate, and based on what I've seen in a couple of big funds where I've seen the information quite recently, the contribution rate required would be north of 30%. However, much depends on length to retirement, the exact detail of the DB being replaced etc.

Difficult to comment on the salary increase required but....

If the DB scheme is now 'hard closed' to existing members, I would think your first question should be how generous is the DC replacement? Only then can you make an informed decision as to whether it's worth moving job etc to try to match the package. Some employers replace DB with quite decent DC schemes in terms of contribution rates, matching etc.

JoeCrystal

[QUOTE=crv1963;76469194I_don't_know_how_to_work_out_exactly_how_much_extra_you_need_to_balance_things_up_if_you_change_jobs_but,_I_was_advised_that_if_I_left_my_scheme_I_would_need_to_earn_between_25%_and_35%_extra_and contribute at least half of my take home pay into a DC pension to get anywhere near as good a pension in retirement.[/QUOTE]

Sound about right to me, although it is important to consider that drawdown is a more realistic option as the annuity rates are so low at the moment.

Something else to bear in mind is that Pete150 mentioned that it was final salary until 2017. What would be interesting to know if the final salary element is frozen at the 2017 salary or still linked to his current salary, which can make it even more generous?

Starting from zero today and assuming Pete150 is 43 years old, wanting to retire at 68 and get 25/60 of the CARE assuming that inflation and payrise match up for the next twenty-five years and assuming he is on 28,800 a year. Eventually, he would be able to get £12,000 a year in 25 years in today's money. To get that and to assume he opted for an index-linked joint-life annuity from 68, he would need to contribute 42% of his salary or £1,050 per month. If he decides to go for drawdown and go for a 4% withdrawal rate, then he would need to contribute 31% of his salary or £775 per month to get a pension pot of £307k.

Of course, these are very rough figures, but it does highlight how generous DB pensions are compared to what the employees are paying.

crv1963

JoeCrystal wrote: »

Sound about right to me, although it is important to consider that drawdown is a more realistic option as the annuity rates are so low at the moment.

Something else to bear in mind is that Pete150 mentioned that it was final salary until 2017. What would be interesting to know if the final salary element is frozen at the 2017 salary or still linked to his current salary, which can make it even more generous?

Starting from zero today and assuming Pete150 is 43 years old, wanting to retire at 68 and get 25/60 of the CARE assuming that inflation and payrise match up for the next twenty-five years and assuming he is on 28,800 a year. Eventually, he would be able to get £12,000 a year in 25 years in today's money. To get that and to assume he opted for an index-linked joint-life annuity from 68, he would need to contribute 42% of his salary or £1,050 per month. If he decides to go for drawdown and go for a 4% withdrawal rate, then he would need to contribute 31% of his salary or £775 per month to get a pension pot of £307k.

Of course, these are very rough figures, but it does highlight how generous DB pensions are compared to what the employees are paying.

So the advice I was given as rough back of a cigarette packet calculations of needing to have a significantly higher salary and pay half into a DC pension were reasonably accurate!

We get an illustration of the worth of the employers contribution to our pension scheme, my baseline salary is around 37k plus shift enhancements which are pensionable but overtime is not. Last year I earned 46k (Salary, enhancements and overtime) but my total package is illustrated as being worth just under 59k so employers pension contribution being worth 13k last year.

So you are right about how generous DB schemes are, I also work with some that prefer to not join it and give themselves a pay rise, not appreciating that all they are doing in reality is rob there future selves of deferred salary!

Pete150

Thanks all for the responses.

So if I can check my understanding:
> As a rule of thumb, to get a similar level of benefit as I would expect from my current DB pension described in my earlier message (1/60th salary per yr), I am looking at having to make a total contribution rate in the region of 25-30% combined employee + employer contribution in to a typical defined contribution pension scheme. This is based on "typical" returns and ignoring investment risk for now.
> So given I am currently putting in a contribution of 11% of salary to get this 1/60th rate, if I was to change job I'd be needing to earn a minimum of circa 14-19% extra on top of my current salary, and putting the full difference in to the pension scheme, to get a broadly equivalent pension.

Does this sound about right?

To answer a few of the queries from the previous responses:

My current pension remains as defined benefit, but In 2017 changed from Final Salary to Career Average going forwards. I have 15 years of contributions up to 2017. Benefits accrued from these years will be based on my salary as of April 2017. They will continue to rise at a rate of CPI + 0.5%, up to a maximum of 2.5% per year, but future pay rises after April 2017 have no further bearing on the benefit.

Going forwards after this date my pension remains as a defined benefit scheme, but is now calculated as career average for the period from 2017 onwards (each year at 1/60th pension). I am 40 and the pension scheme retirement age is 65 so have at least another 25 years to work (recognising the state pension age is 68).

One thing I didn't quite understand was the comment about I'd have to earn 25-35% more and put half in to a pension - I assume this is factoring in that it would have to be worth getting an overall pay rise of say 10-15% on top of the additional pensions contributions, to make it financially worthwhile to change jobs?

Thanks,
Pete

Marcon

Pete150 wrote: »

One thing I didn't quite understand was the comment about I'd have to earn 25-35% more and put half in to a pension - I assume this is factoring in that it would have to be worth getting an overall pay rise of say 10-15% on top of the additional pensions contributions, to make it financially worthwhile to change jobs?

If you've got 25 years to go to retirement, you are very wise to think about pensions - but with another quarter of a century in the workplace, perhaps giving priority to a job you love doing, rather than one which can match your current pension (which might in any case change again and not for the better!), should be the priority?