Calculation method changed on db pension for early retirement

Pat38493

bolwin1 said:

A worked model using your proposed method. If inflation averages out at 4% and the reduction is 4% for each year the pension is taken early, then everyone would take the pension early, as you'd end up at the same level of pension at NRA, but with the advantage of 10 years payments from 55 to 65. Clearly, that's not going to be viable for the pension scheme. 

It's also worth pointing out that comparing total pension drawn starting at 55 compared to total pension starting to be drawn at 65 does not show the full picture. 

Shimrod's numbers - 

age 55

£21,196 = £958,000

age 65

£35,327 = £974,500

The £958,000 figure is worth much more than the £974,500 as a significant chunk of it is drawn 10 years earlier pre inflation.  

 

I'm not sure if we are at cross purposes there because in all 3 of the methods I described above, I calculated some examples and they all gave pensions at 55 much lower than at 65 - none of them gave the same pension at 55 as at 65.

I applied an inflation calculation going forward using a future value type formula and assuming 3% growth per year, and then I used a 4% reduction for the early retirement.  The 4% reduction was just a flat calculation so 10 years = 40% - this is what was being done earlier in the thread so I assumed this was correct.

Are you saying that this type of calculation is not right because the penalty of starting to pay out the money 10 years earlier is somehow more?

The way I was also looking at it, let's say I was paid a pension of starting £35k and I lived to 89.  IF I assumed 3% inflation, and it would cost the scheme payments of about £1.2m over my life over 24 years.

If I retired at 55, but still live to 89, I would have 34 years of payments - in order to cost the scheme about the same cash with 3% inflation, my pension would need to be about £21k.

This is pretty consistent also with the actual estimates issued by my DB pension company when I have requested them in the past.

Using what is described above as the "standard" method, I would only be offered a pension about £15k in some scenarios.  This would only cost the pension scheme £923k over the lifetime - almost a 25% reduction.

What you are suggesting is that the calculations are not valid because the first 10 years of payments are coming out earlier than when you only claim your pension at NRA - therefore there would be about £240K coming out of the scheme in earlier years?

That seems like a pretty big downward adjustment on the pension as the only difference there is the cumulative potential growth of the first 10 years of payments - given that the total payments to be issued in first 10 years, are less than the overall cash difference between 923K and 1.2M, I fail to see how this can be a fair adjustment.

Of course it may be that this is what is happening in many schemes, but it doesn't seem to be a fair way to me.

However - then this doesn't explain why the estimates I am getting from my pension scheme seem to be calculated based on what I proposed rather than the "standard".

Shimrod

bolwin1 said:

It's also worth pointing out that comparing total pension drawn starting at 55 compared to total pension starting to be drawn at 65 does not show the full picture. 

Shimrod's numbers - 

age 55

£21,196 = £958,000

age 65

£35,327 = £974,500

The £958,000 figure is worth much more than the £974,500 as a significant chunk of it is drawn 10 years earlier pre inflation.  

 

I think the 'total cash' difference between the £14K and £21K is too large even allowing for pre-inflation. The same exercise on my pension using the scheme calculation would give a difference of £120K total between retiring at 55 and 65. My scheme has a higher penalty for early retirement which would explain most of that increased difference.

if @toolateforsums would share pension value at the point the pension closed to accrual and the year it closed, it should be easy to check the figures using statutory revaluation to see which one is in the ballpark.

bolwin1

Pat38493 said:

bolwin1 said:

That seems like a pretty big downward adjustment on the pension as the only difference there is the cumulative potential growth of the first 10 years of payments - given that the total payments to be issued in first 10 years, are less than the overall cash difference between 923K and 1.2M, I fail to see how this can be a fair adjustment.

You need to look at it from the point of death (assume 89) when the scheme has discharged it's liabilities. That is the point at which the £923K / £1.2M figures come into play. The 'real cost' to the scheme at that point is every payment made affected by compound inflation from that point all the way up to death. This will be a lot higher for payments made in those first 10 years, due to the compounding effect over 34 years. e.g. £10000 paid out 34 years ago would be worth £28,000 in today's money. I can easily believe the 25% figure difference in the cash sums. If you put that into a spreadsheet, I'm pretty sure the 'real cost' numbers would come out very similar.

It's also worth pointing out that early retirement factors / scheme rules are underpinned by numbers from the actuaries who do these calcs all of the time. Whilst they aren't the most exciting people I've ever met, they do know their spreadsheets 

Pat38493

Shimrod said:

bolwin1 said:

It's also worth pointing out that comparing total pension drawn starting at 55 compared to total pension starting to be drawn at 65 does not show the full picture. 

Shimrod's numbers - 

age 55

£21,196 = £958,000

age 65

£35,327 = £974,500

The £958,000 figure is worth much more than the £974,500 as a significant chunk of it is drawn 10 years earlier pre inflation.  

 

I think the 'total cash' difference between the £14K and £21K is too large even allowing for pre-inflation. The same exercise on my pension using the scheme calculation would give a difference of £120K total between retiring at 55 and 65. My scheme has a higher penalty for early retirement which would explain most of that increased difference.

if @toolateforsums would share pension value at the point the pension closed to accrual and the year it closed, it should be easy to check the figures using statutory revaluation to see which one is in the ballpark.

Reflecting on this further I guess @bolwin1 must be correct in some way and I found some documents which I can't really interpret.

If you use the method that I proposed, in the case where a person had a deferred pension of £20k age 54, and they then chose to retire at 55 (10 years early), they would receive a pension of more than £20k, even though they were retiring 10 years early and only one year has passed since the deferral - from a gut feel point of view, this doesn't seem be right can it?

Therefore in this scenario, it feels obvious that some kind of further early retirement reduction is needed, unless I am completely misunderstanding the meaning of "deferred pension value".

However - I did find a fact sheet about the DB scheme I am in and there is a section as follows:

MALE: Pre Barber & Post Equalisation tranches

GMP – Revalue from DOL to NRD then apply ERF from age 65.

XS – Complete years revaluation from DOL to NRD then apply ERF

from age 65.

Interim 17/05/1990 – equalisation date

GMP – Revalue from DOL to Age 60. Then LRF to ERD if ERD>60 or

ERF from age 60 if ERD<60.

XS – Complete years revaluation from DOL to Age 60. Then LRF to

ERD if ERD>60 or ERF from age 60 if ERD<60.

FEMALE: Pre Equalisation

GMP – Revalue from DOL to Age 60. Then LRF to ERD if ERD>60 or

ERF from age 60 if ERD<60.

XS – Complete years revaluation from DOL to Age 60. Then LRF to

ERD if ERD>60 or ERF from age 60 if ERD<60.

Post Equalisation

GMP – Fixed rate revaluation from DOL to Age 60. Then Statutory

Late Payment Increases to age 65. Then apply ERF.

XS – Complete years revaluation from DOL to NRD. Then apply ERF.

Assumed future revaluation factors: 2.5% per annum.

I am not sure what GMP or XS means, but this seems to mean that it is revalued to NRD and then apply early retirement reduction.

There is also a table of "early retirement factors" which are not linear, going down to 0.513 for retirement at 55 with reductions of 6-7% or so each year (which according to earlier posts on this thread seems quite high).  Possibly the higher factors are how they adjust for the fact that they are revaluing forward to NRD according to the original scheme rules.

This is the other point we have maybe been missing - the factors are not necessarily linear.

For my scheme, I am also now scratching my head because when I requested 2 estimates last year for retirement at 65 and 57.  The retirement factor in the factsheet for age 57 is 0.582.  However, the pension they quoted me for retirement at 57 is 65% of the value they gave at 65.  Therefore now I am wondering if the estimate they have given me also is wrong unless "apply retirement factor" doesn't mean what it seems to mean.  The pension they are quoting for age 65 seems about right based on the original deferred amount and estimating 2.5% increase compounded per year over 26 years.

DT2001

GMP is Guaranteed Minimum Pension and relates to the part of your pension accrued of your scheme opted out of SERPS (split pre and post 88)
XS is the excess i.e. difference between total pension and GMP element.
GMP complicates the discussion so can be ignored in the OP’s case.

Hopefully a worked example of how I think it works will help.
You work for 20 years with a 80th year scheme. 

Your scheme closes when you are earning £40k.
At NRD, say 65, you will get £40k x 20/80 = £10k
Every year this will increase by RPI or CPI so you still receive, in real terms, £10K
If you decide to take before 65 your £10k in real terms will be actuarially reduced by the factor decided by actuaries.
If the scheme closes when you are 55 and you decide to take a pension immediately you get £10k less the ERF so circa £6k.
If you wait until 65 you get £10k (in real terms)
If you use the method of ‘guessing’ the value at 65 and suggest compounded inflation would take the pension to £15k then apply the ERF you would get £9k p.a. Increasing each year by the same as the deferred pension. You would have £90K, in real terms, by NRD so everyone would take the pension asap.
The OP needs to tell us the value of the pension at date of closure of the scheme so we can see what is realistic.

Normally the crossover point, ignoring all other factors, is mid 70’s - so if you live beyond that age you would have been better to wait until NRD.

Each persons case is different. It maybe that taking your pension early means prior to SPA you pay no tax on it or allows your DC pot to grow or allows earlier retirement.

Pat38493

bolwin1 said:

Pat38493 said:

bolwin1 said:

That seems like a pretty big downward adjustment on the pension as the only difference there is the cumulative potential growth of the first 10 years of payments - given that the total payments to be issued in first 10 years, are less than the overall cash difference between 923K and 1.2M, I fail to see how this can be a fair adjustment.

You need to look at it from the point of death (assume 89) when the scheme has discharged it's liabilities. That is the point at which the £923K / £1.2M figures come into play. The 'real cost' to the scheme at that point is every payment made affected by compound inflation from that point all the way up to death. This will be a lot higher for payments made in those first 10 years, due to the compounding effect over 34 years. e.g. £10000 paid out 34 years ago would be worth £28,000 in today's money. I can easily believe the 25% figure difference in the cash sums. If you put that into a spreadsheet, I'm pretty sure the 'real cost' numbers would come out very similar.

It's also worth pointing out that early retirement factors / scheme rules are underpinned by numbers from the actuaries who do these calcs all of the time. Whilst they aren't the most exciting people I've ever met, they do know their spreadsheets 

OK well I don’t know because after 10 years, the NRA case will be taking money out much faster.

Question is - is there a magic formula in Excel to calculate this or do you have to create a model with a row for every month of retirement (408 rows on a 34 year model) and then calculate the fund’s cash position per month?

I suppose the formulas like FV in Excel won’t take care of this because there are 2 separate growth rates involved - growth of the outgoing payments by RPI or whatever, and growth of the remaining fund assets each month.

Pat38493

DT2001 said:

GMP is Guaranteed Minimum Pension and relates to the part of your pension accrued of your scheme opted out of SERPS (split pre and post 88)
XS is the excess i.e. difference between total pension and GMP element.
GMP complicates the discussion so can be ignored in the OP’s case.

OK but did the OP ever say that his scheme was not contracted out of SERPS at any time?  I don’t see that?  If it was, wouldn’t this also be a factor?  

For example in my case, my estimated pension if I retire at 57 from the scheme admins is 18K, but if I applied the ERF listed in the fact sheet for age 57 to their figure for NRA at 65, I would get 14K.  Either they have made a mistake in their estimate, or there is something different about the way the GMP portion is calculated - in the fund factsheet it seems to imply different rules of how the valuation and ERF are applied for GMP vs XS and possibly even for different periods of service pre and post equalisation.

If the OPs scheme has the same complexities then the simplistic discussion here isn’t going to cover it all?

bolwin1

Pat38493 said:

OK well I don’t know because after 10 years, the NRA case will be taking money out much faster.

Question is - is there a magic formula in Excel to calculate this or do you have to create a model with a row for every month of retirement (408 rows on a 34 year model) and then calculate the fund’s cash position per month?

I suppose the formulas like FV in Excel won’t take care of this because there are 2 separate growth rates involved - growth of the outgoing payments by RPI or whatever, and growth of the remaining fund assets each month.

I'm not aware of a simple function that would do this, but I'm not an excel expert by a long shot. 

I think if you used annual figures, one row per year, you'd get a pretty close comparison. Hopefully, the pension statements contain something about what assumptions they have used for future inflation, as they should be the ones you use in the models. 

n.b. as has been highlighted above, this would only work if there's no GMP involved as you'd have 2 different rates that different pats of the pension increased at.

Some other things that the actuaries may take into account to make the comparisons fair would be having to make an allowance for death shortly after taking the pension where a minimum amount (e.g. 3 years pension) would still be paid out & also spouse pension for a surviving partner. One of these favours early retirement & one favours late retirement. To be honest, it would get really complicated at this point & these are less of a consideration than the main calculations, but may help explain any outstanding discrepancy once the 'real cost' figures have been determined. 

DT2001

Pat38493 said:

DT2001 said:

GMP is Guaranteed Minimum Pension and relates to the part of your pension accrued of your scheme opted out of SERPS (split pre and post 88)
XS is the excess i.e. difference between total pension and GMP element.
GMP complicates the discussion so can be ignored in the OP’s case.

OK but did the OP ever say that his scheme was not contracted out of SERPS at any time?  I don’t see that?  If it was, wouldn’t this also be a factor?  

For example in my case, my estimated pension if I retire at 57 from the scheme admins is 18K, but if I applied the ERF listed in the fact sheet for age 57 to their figure for NRA at 65, I would get 14K.  Either they have made a mistake in their estimate, or there is something different about the way the GMP portion is calculated - in the fund factsheet it seems to imply different rules of how the valuation and ERF are applied for GMP vs XS and possibly even for different periods of service pre and post equalisation.

If the OPs scheme has the same complexities then the simplistic discussion here isn’t going to cover it all?

I wrote that reply late at night and cannot now think why I suggested ignoring GMP!
It maybe that if the OP is male then NRD = GMP age - 65
If there is an element of GMP there could be an uplift at 65.
It doesn’t change the concept of revaluing to NRD applying ERF and then increasing from ERD to NRD.

We need the OP’s rules because as you suggest it can/is complex.

In your case do you have a GMP element or does the scheme provide a ‘bridge’ and then a reduction at SPA?

My scheme originally revalued your GMP to ERD and then applied ERF but changed as it was considered too generous! Legal advice was taken to confirm the change. It probably only was considered when redundancies were offered with pension being available between 50 and 60 - if you resigned no option for early drawing was possible.

Pat38493

DT2001 said:

In your case do you have a GMP element or does the scheme provide a ‘bridge’ and then a reduction at SPA?

My scheme originally revalued your GMP to ERD and then applied ERF but changed as it was considered too generous! Legal advice was taken to confirm the change. It probably only was considered when redundancies were offered with pension being available between 50 and 60 - if you resigned no option for early drawing was possible.

I wrote a whole reply to this but when I pressed "post comment", it all disappeared!

I don't have time to re-type it all now so I will have to come back later but quickly:

- Not sure what you mean what is SPA?

- Last estimates I have were seemed to be having GMP and contracted out according to the pension factsheet.

- I went through documents - actually, in late July last year, the pension GMP was converted to non GMP, and I now have a table showing "before and after" for all the values.  However this happened after I received the last estimates and factsheet, so the numbers I posted above are based on GMP vs XS calculations as far as I understood.

The table appears to show the pension split into 3 different categories with different retirement ages (!), different post retirement growth rates.  The pre-retirement revaluation appears to be now based on stautory RPI to 2010 then CPI capped 5%.
It appears to show that for a significant portion of my deferred pension, my retirement age is 60, which I suppose is a nice surprise!

This is the new info - I would have to post you some data from the July factsheet for the old info as this is what the last pension estimate at 57 of 18K was based on.