What is a DB pension worth compared to the typical salary?

michaels

SO I set up an excel spreadsheet and imagined someone who retires at 62 after 40 years employment with a pension that gave 1/80ths of final salary so a pension of 16k if the retirement salary is 32k.

I then costed buying an index linked annuity of 16k joint life, 50% for surviving spouse, RPI linked.  This costs 758k.

I then assumed the 32k salary had seen annual increases of 3% more than inflation for the 40 years and that investments had grown by 5% per year over inflation.

Crunch the numbers and this would mean that the final salary contributions would have been worth 40% of the annual salary paid each year - ie someone in without a DB pension would need to have been earning 40% more each year (so £44.4k in the retirement year) and contributed 28.6% of their gross salary each year to get the same pension value.

I'm not sure what the current level of pension benefit a typical public sector worker gets now but a rule of thumb might be that you need to add 40% to a public sector salary to work out what an equivalent non-DB remuneration package would be.

GunJack

Why do people keep comparing DB pensions to the cost of an annuity?? I'll bet it doesn't cost the pension scheme the numbers quoted in these sort of comparisons, and neither do the majority of pensioners go out and buy one any more...

..and there are still DB schemes available in the private sector, so stop bashing civil service & public sector.

drumtochty

It depends on the actual pension scheme as some were or are still better than 1/80 a year.

I would agree that you are in the ballpark of what would have to be earned over and above the notional salary that the person receives.

As always many things have to be taken into account including what the person has deducted from their wages as their contribution to the scheme.

In my own case, doing a similar calculation, My contribution was some 5% of the value of what would be needed to finance the pot required over the 22 years that I worked for the company.

I had no pension reduction from retiring at 57. Before then it was not attractive to leave before 57 as in my opinion the extra sums earned from going "contract" would not cover the costs of the pension.

I left at 57 and over the period up to around 64, I worked 30% of the time on a limited company basis and my extra earnings more than covered what I would have earned up to mid 80's from the increased final salary pension from my 64th birthday.

Therefore with many years service in a final salary scheme and "an in demand" skill set that I have, it is possible to leave after a good numbers of years service and be able to cover the benifit in other ways.

daveyjp

Lockdown is leaving people with too much time on their hands.

michaels

GunJack said:

Why do people keep comparing DB pensions to the cost of an annuity?? I'll bet it doesn't cost the pension scheme the numbers quoted in these sort of comparisons, and neither do the majority of pensioners go out and buy one any more...

..and there are still DB schemes available in the private sector, so stop bashing civil service & public sector.

Not bashing just some public sector workers do not seem to be aware how much their pensions are worth when they claim they are aid much less than their private sector counter parts (I know that is a whole other conversation and actually they are paid similar according most analysis).

Re your comment that it doesn't cost a DB pension provider the same as it costs to buy an annuity, I was wondering what you based that on - surely both are a fixed commitment and will require the same size fund to support them?

strawb_shortcake

Also public sector is now career average and not final salary with only those nearing retirement age still in line for FS. 
I don't think you'll find anyone in the public sector that has had 3% year on year pay increase either. 
Working in the public sector, I see and what my counterparts in industry earn and hear what types of lifestyles they lead and see the cars they drive. Yes they earn far more than us, their pension is broadly similar in many of the companies and other benefits and perks are comparable. We obviously don't get company cars or share purchasing opportunities.

german_keeper

I might be misunderstanding this but annual pay rise of 3% more than inflation every year for 40 years?????

Albermarle

Yes they earn far more than us, their pension is broadly similar in many of the companies and other benefits and perks are comparable. We obviously don't get company cars or share purchasing opportunities.

I can not agree with the bit about pensions . Final salary or even career average schemes have been decimated in the private sector. Although some older employees will still have some benefits from now defunct schemes, more recent employees will be in a bog standard DC scheme with the employer paying 4% to 10% , usually the former.

The OP estimated a 40% benefit, which may or may not be correct . What I do know is that many employers who ran DC schemes typically contributed 20 to 25% and then  top ups when needed. Which is why so many stopped and moved to the much cheaper DC schemes. 

Marcon

michaels said:

GunJack said:

Why do people keep comparing DB pensions to the cost of an annuity?? I'll bet it doesn't cost the pension scheme the numbers quoted in these sort of comparisons, and neither do the majority of pensioners go out and buy one any more...

..and there are still DB schemes available in the private sector, so stop bashing civil service & public sector.

Re your comment that it doesn't cost a DB pension provider the same as it costs to buy an annuity, I was wondering what you based that on - surely both are a fixed commitment and will require the same size fund to support them?

No. A DB pension scheme isn't run to make a profit, whereas annuity providers (typically insurance companies) are. That's why if you wind up a DB scheme, even if it is fully funded as a going concern, the buy out cost will normally require a substantial injection of cash before any insurer would touch it.

Dox

michaels said:

I then assumed the 32k salary had seen annual increases of 3% more than inflation for the 40 years and that investments had grown by 5% per year over inflation.

Crunch the numbers and this would mean that the final salary contributions would have been worth 40% of the annual salary paid each year - ie someone in without a DB pension would need to have been earning 40% more each year (so £44.4k in the retirement year) and contributed 28.6% of their gross salary each year to get the same pension value.

Wildly inaccurate assumptions if you look back at the history of wage increases.

Also a completely inaccurate model of how DB schemes are funded. Contributions in the earlier years are very much lower than in later years.

The NHS is tackling the lack of knowledge (and creating further confusion in the process, but at least they're giving it a go): https://www.nhsbsa.nhs.uk/employee-section/understanding-my-statement/hypothetical-annuity-cost

michaels

My understanding is that long term real wages increase by about 2% per annum.  However over the typical career an employee does not stay in the same job, they progress up their pay spine and potentially get promoted to a higher grade.  I agree that recently the public sector have not seen annual increases at all (let alone real terms) but I am sure most at least those in 'professions' have seen the sort of salary progression I am talking about.