CARE pension dialling up cost vs. payback - Confused

Bossworld

I feel I'm missing something fundamental, can someone please give me some guidance?

I currently dial up my pension from 1/95 to 1/80, at a gross cost to me of 6% of pensionable salary.

To go from 1/80 to 1/65 would cost an additional 9.5% on top of the 6%.

I've done some simple Excel spreadsheets, and used work's pension calculator, but from what I can tell, even accounting for the savings in PAYE/NI, you need to be confident you're going to live well beyond retirement age just to see a return?

I realise that cost may come down as it gets revalued each year, but my back of a fag packet maths still suggests 8 years, at a 3% revaluation. If so, presumably it's best to frontload the extra contributions when you're younger and stop dialling up as you get closer to pension age?

Thank you

(Illustrative example, not my salary and not my intention to work that late)

£95k salary, no additional contribution would be a year 1 pot of £1k.

Dialling up to 1/65 would mean a year 1 pot of £1461, with simplified extra contribution of (£14,725*0.58) = £8540

After 30 years of 3% revaluations, that year 1 pot is worth either £2356 or £3444

That difference of £1087 means you'd need to receive your pension for 13.5 years to get the gross difference back, or 7.8 years to get the simplified net back? (Of that year's extra contribution)

Bossworld

Is there a more appropriate sub forum to post this in?

PandaGirl6

You've asked a question that would be best answered by an IFA dealing with DB pensions.
Often an initial consultation is free, so shop around.

Ps. You'd need to give them more info. Schemes have different rules. Is it a final salary you've got? If so how many years are taken into account etc.

NedS

Bossworld said:

I feel I'm missing something fundamental, can someone please give me some guidance?

I currently dial up my pension from 1/95 to 1/80, at a gross cost to me of 6% of pensionable salary.

To go from 1/80 to 1/65 would cost an additional 9.5% on top of the 6%.

I've done some simple Excel spreadsheets, and used work's pension calculator, but from what I can tell, even accounting for the savings in PAYE/NI, you need to be confident you're going to live well beyond retirement age just to see a return?

With a DB pension, because it provides a guaranteed income for life, it's as much about purchasing that guarantee as just seeing a positive return. You can consider it insurance against living for a very long time and be very grateful you made that investment should you live to 100, and if you die young, I doubt you will much care that you never saw a positive return.

Bossworld said:

I realise that cost may come down as it gets revalued each year, but my back of a fag packet maths still suggests 8 years, at a 3% revaluation. If so, presumably it's best to frontload the extra contributions when you're younger and stop dialling up as you get closer to pension age?

Presumably the 3% is the amount the pension revalues each year, and is designed to offset inflation?

As you are talking about 1/95ths and 1/80ths, is this a final salary scheme or is this just the accrual rate and it revalues at 3% each year regardless of final salary and inflation? If it's final salary, then revaluation only normally occurs once the pension is deferred (i.e, you've left the job before pensionable age) or the pension is in payment. With a final salary DB pension, the inflation protection during accrual comes from the link to final salary and is reliant on that matching (or exceeding) inflation over your working lifetime.

Most final salary schemes benefit the participant when your salary increase through promotion later in your career versus someone who stays at the same grade throughout, so if that is likely to happen then contributions in early years represent better value.

It is not easy to model or get a direct comparison if the scheme represents good value for you. The closest direct comparison would be a comparable annuity and how much that would cost you to purchase, but you will only get a quote for that at or near retirement age (and you may be a long way from that), and as recent events have demonstrated, annuity rates can vary wildly with interest/gilt rates at the time.

Other than that, about all you can do is try to predict how investments of the same amount of money into a DC scheme may perform, but noting that DC schemes do not provide any sort of guarantee and there is a cost to that. Most people here agree the sweet spot is to have a mixture of guaranteed DB income to cover essential living costs combined with the flexibility of DC / Cash (ISA) investments. As guaranteed DB schemes are like becoming hens teeth unless you work in the public sector, you may view it that it is worth building up a good amount of guaranteed DB pension income now whilst you have the chance as you may not have that opportunity later in your working life. I would NOT want to be that person retiring in 20 years time with only DC pension assets and totally exposed to market movements, but who knows, if/maybe when DB pensions die out, interest rates may be higher and index-linked annuities may again become the go to choice for providing that guaranteed income element in retirement planning.

EDIT: Sorry, I missed you mentioned it's a CARE scheme in the thread title so ignore the final salary references above

Bossworld

Many thanks for the replies, apologies for not quoting, it's currently causing havoc with the Samsung mobile browser for some reason.

Yes it's a CARE (career average revalued earnings) scheme rather than final salary. The figures I put were just an example, I'm not earning anything near that but it was an easier way to demonstrate a base 1/95 level.

I doubt it'll be a flat 3% revaluation over that length of time (if anything it's likely to be less) but that then widens the chasm. Each year, the value of each prior year's pot is revalued in line with CPI, I believe, so this year will likely be skewed.

I wasn't after specific financial advice, more a general sanity check as to the value (or lack of) in these dialling up and down options. Perhaps people with these schemes are less engaged with these forums but was just hoping someone else further on in their career may have done similar theoretical maths.

I do have a separate DC pot built up over 10 years with another employer and that's also used as a vehicle for ad-hoc contributions with my current employer. Agree with you about balancing risk; I've many years left before I can touch that scheme but at the start of the pandemic I vaguely recall I shifted 50% of my funds away from a 7/7 risk Asian based fund over to a 4/7 US one, and then they performed equally badly for a period!

Thank you for the advice, I'll do some more modelling with regards the value in dialling up to 1/65, versus putting that money in the DC pot.

bolwin1

I presume the scheme administrators have to weigh up the costs to the taxpayer (?) vs the benefit to the individual. 

If this is the case, then maybe the cost of the pension dialup is designed to be cost neutral - i.e. the break-even point would be around 80 years old ? A good deal if you intend to live a long time, less so if you don't (like most DBs).  

It would then be a case of you weighing up your personal life expectancy vs. average & your preference for guaranteed income vs. investing in a DC pension. 

Bossworld

That would make sense, I take NedS' point above about a "guaranteed income" as the driving factor behind that.

The 'cost' of dialling up, in comparison to the possible bands, (e.g. 1/50 would be a cumulative cost of 30%, versus the stock 1/95) seems huge but I suppose it's that or 'losing' it to PAYE and NI.

To your last point, I need to go away and research my DC options in comparison/conjunction.

NedS

I'm currently in a CARE scheme, Civil Service Alpha. I currently purchase additional pension each year as I'm looking to increase the amount of guaranteed index-linked income in retirement. Like you, I have a DC pot also.

At my age, I pay around £12,700 to purchase an extra £1000 of added pension at age 67. That's around a 7.8% return (at age 67), index linked for life. The younger you are, the cheaper it should be but the longer you have to wait to access it.

If I were younger, I may be more tempted by investing in a DC pot as I would have a 20-30 year investment window so could happily add £1,000 into a global equity tracker each month and forget about it, but being close to retirement, I am a little more cautious. I'm pretty much done, I have what I need and am on the final big push, topping up the DB to ensure I have sufficient guaranteed income to enable me to sleep at night when stock markets plunge by 50%.

If you are young, to an extent I do not think it matters so much whether you go the DB or DC route - the IMPORTANT thing is that you are ploughing extra cash into your pension and either will hold you in good stead. If you really can't decide, either do 50:50, or go the DC route when markets are crashing / looking cheap and max out the DB in years when stocks are looking expensive and you are wary of purchasing more. The important thing is to keep investing and growing your assets.

daveyjp

The return is the monthly guaranteed income you receive.  If you want more monthly income put more in, if you can live on the basic level do so. You could always pay into a SIPP so you also have a cash pot on retirement if that is preferable.

Don't see it as trying to get back all you put in, DB is a deferred salary payment, not a savings pot you draw on..

You  could die a month after retirement, you may receive payment for longer than you have paid in. Either way you will get the same monthly payment.

Bossworld

NedS - it sounds like a well trodden path for you then and thank you for sharing your rationale. I think for now then it probably makes sense to continue the 'dial' up to 1/80 on the DB scheme, and continue to put any performance award that would otherwise result in 40% PAYE or HICBC into the DC pot on a more ad hoc/tax efficiency basis.

Useful comparison Davey (delayed salary, thank you.