Help! I don't understand how my pension works

leypt1

Hi all,
Apologies for the very basic question. I am trying to understand my pension better/improve my financial literacy, and have spent the afternoon reading the scheme (Local Government Pension Scheme) brochure, but it's raised more questions than answers. Please note that my baseline level of knowledge is absolutely zero but I've read a lot from this site and the money advice service and am trying my best!

The scheme is defined benefit. The brochure says that each year, a sum of money is added to the pension account equalling 1/49th of my pensionable salary. It doesn't explain what this means, but assuming it's my gross salary, that would work out as £990 per year.
However, my payslip shows that 8.5% of my gross salary (i.e. around 1/12th) is taken out every month. This is again in line with the brochure, which lists 8.5% as the contribution rate for my salary. However, this 8.5% figure is then not mentioned in the section about how the pension account is built up each year.

So my question is - what the heck is happening to the £350 that gets deducted from my payslip every month? Is the brochure just badly explaining that my pension account is the sum of my contributions plus an additional £990pa, or are my contributions just...disappearing into the ether? 

Here is the link to the brochure which I read (it's not specific to my employer): https://www.nottspf.org.uk/media/114269/lgpen-12-brief-guide-to-lgps.pdf

Thanks for any insight!

leypt1

A second question - the brochure says that the amount of pension actually received will be 1/60th of my final salary (paid - monthly? annually?? it doesn't say), even though the amount put into the account each year will be 1/49th of my salary.

Why does it pay out less than you put in? I assume I am missing something huge, as presumably nobody would ever enroll in a pension if they don't receive an amount at least equal to what they put in? Especially if you compare it to, e.g. investing, at which point you could expect to receive an amount greater than what you put in.

Dazed_and_C0nfused

You are not building up a pot of money.

You are paying £4,200/year (before tax relief).

In return you will get a pension of £990.  Per year.  From normal pension age.  For the rest of your life.  And no doubt index linked.

Where else could you get that return?

Silvertabby

Ignore your (and your employer's) contributions.  They have no bearing on your eventual pension.

As you have realised, your pension accrues at 1/49th of your pensionable pay each year, plus annual revaluation (CPI - will be 0.5% next April). 

Using your own figures of £350 per month contributions and £990 per year pension accrual, for one year you pay £4,200 in return for £990+ of indexed linked pension per year for the rest of your life. 

Dazed_and_C0nfused

leypt1 said:

A second question - the brochure says that the amount of pension actually received will be 1/60th of my final salary (paid - monthly? annually?? it doesn't say), even though the amount put into the account each year will be 1/49th of my salary.

Why does it pay out less than you put in? I assume I am missing something huge, as presumably nobody would ever enroll in a pension if they don't receive an amount at least equal to what they put in? Especially if you compare it to, e.g. investing, at which point you could expect to receive an amount greater than what you put in.

That brochure only mentions 1/60th once, in relation to service under the previous pension scheme

This is a defined benefit (DB) pension, what you get back is not reliant on investment returns.

leypt1

Dazed_and_C0nfused said:

You are not building up a pot of money.

You are paying £4,200/year (before tax relief).

In return you will get a pension of £990.  Per year.  From normal pension age.  For the rest of your life.  And no doubt index linked.

Where else could you get that return?

Thank you for this response. Again though, I think I'm missing something really fundamental - why not pay £4200pa into a bank account for 25-35 years until I retire? Even assuming 0% interest and 0% returns if I invest (but also 0% inflation), I could then use the money at a rate of £4200 per year for 25-35 years after I retire?

This question will probably fully expose the limits of my knowledge, thanks again for any help.

Albermarle

Your contributions are just an arbitary % set by the employer/scheme as a general contribution to the coffers of the scheme. They do not directly affect your actual pension, which is governed by the rules of the scheme. 
You may also be underestimating the cost of providing a guaranteed income ( increasing with inflation )from retirement until you die. For example if you did not have this pension and you wanted at say age 60 buy a guaranteed pension of £200 per month , inflation linked , you would have to cough up well over £100K 

NoMore

leypt1 said:

Dazed_and_C0nfused said:

You are not building up a pot of money.

You are paying £4,200/year (before tax relief).

In return you will get a pension of £990.  Per year.  From normal pension age.  For the rest of your life.  And no doubt index linked.

Where else could you get that return?

Thank you for this response. Again though, I think I'm missing something really fundamental - why not pay £4200pa into a bank account for 25-35 years until I retire? Even assuming 0% interest and 0% returns if I invest (but also 0% inflation), I could then use the money at a rate of £4200 per year for 25-35 years after I retire?

This question will probably fully expose the limits of my knowledge, thanks again for any help.

Because (ignoring any change in salary and you stay in the job) after 25 years in the scheme you will get £24750 (25 x 990) per year from the pension.

leypt1

leypt1 said:

Dazed_and_C0nfused said:

You are not building up a pot of money.

You are paying £4,200/year (before tax relief).

In return you will get a pension of £990.  Per year.  From normal pension age.  For the rest of your life.  And no doubt index linked.

Where else could you get that return?

Thank you for this response. Again though, I think I'm missing something really fundamental - why not pay £4200pa into a bank account for 25-35 years until I retire? Even assuming 0% interest and 0% returns if I invest (but also 0% inflation), I could then use the money at a rate of £4200 per year for 25-35 years after I retire?

This question will probably fully expose the limits of my knowledge, thanks again for any help.

Hang on, is it that for each year I pay in, I get an *additional* £990 *per year*?

i.e. If I have been employed for one year and then retire, I have paid £4200 but get £990 per year in retirement (maybe £29k if I live for another 30 years) 
If I have been employed for 10 years I have paid £42,000 but get £9900 back per year in retirement (maybe £297k in total if I live for another 30 years)

leypt1

NoMore said:

leypt1 said:

Dazed_and_C0nfused said:

You are not building up a pot of money.

You are paying £4,200/year (before tax relief).

In return you will get a pension of £990.  Per year.  From normal pension age.  For the rest of your life.  And no doubt index linked.

Where else could you get that return?

Thank you for this response. Again though, I think I'm missing something really fundamental - why not pay £4200pa into a bank account for 25-35 years until I retire? Even assuming 0% interest and 0% returns if I invest (but also 0% inflation), I could then use the money at a rate of £4200 per year for 25-35 years after I retire?

This question will probably fully expose the limits of my knowledge, thanks again for any help.

Because (ignoring any change in salary and you stay in the job) after 25 years in the scheme you will get £24750 (25 x 990) per year from the pension.

This penny has just dropped - thank you so much! I was genuinely quite distressed by the thought of having paid all that money every month for a measly £990 pa when I retire...

Dazed_and_C0nfused

leypt1 said:

NoMore said:

leypt1 said:

Dazed_and_C0nfused said:

You are not building up a pot of money.

You are paying £4,200/year (before tax relief).

In return you will get a pension of £990.  Per year.  From normal pension age.  For the rest of your life.  And no doubt index linked.

Where else could you get that return?

Thank you for this response. Again though, I think I'm missing something really fundamental - why not pay £4200pa into a bank account for 25-35 years until I retire? Even assuming 0% interest and 0% returns if I invest (but also 0% inflation), I could then use the money at a rate of £4200 per year for 25-35 years after I retire?

This question will probably fully expose the limits of my knowledge, thanks again for any help.

Because (ignoring any change in salary and you stay in the job) after 25 years in the scheme you will get £24750 (25 x 990) per year from the pension.

This penny has just dropped - thank you so much! I was genuinely quite distressed by the thought of having paid all that money every month for a measly £990 pa when I retire...

You will have paid £4,200 in return for £990.

But you are only paying that £4,200 once.  You could get the £990 for 30+ years