Is your work pension any good?

Work pensions are an increasingly endangered species. We show you how to size up your pension scheme.
Since the late Nineties, occupational (workplace-based) pension schemes have been under attack as employers cut their costs. This has led to many organisations curbing or even closing altogether their pension schemes.
However, this 'withering' of pension schemes has taken place almost exclusively in the private sector.
Two decades ago, most large private sector employers offered final salary pensions to new joiners. Today, the vast majority of these schemes have been shut down to new joiners. Now only one in nine (11%) of the UK's 23 million private sector workers belong to schemes paying final salary pensions.
On the other hand, more than nine in ten public sector employees get gold-plated pensions.
How good is your scheme?
When moving job or changing employer, it's important to check your future pension entitlements. In fact, after your basic salary (and bonus, if you get one), the most important factor to consider when weighing up a job offer is the pension you'll get.
This is because pensions are simply future pay, so not joining a good pension plan is like turning down a pay rise -- every year, for life. Here's what to look for in a pension scheme...
Final salary (defined benefit) schemes
Final salary plans are the 'gold standard' of pension schemes.
The joy of a final salary scheme is that the employer takes all of the investment risk and longevity risk (how long you'll live), while promising you a pension based on your years of service and salary on retirement.
Alas, thanks to their sky-high running costs, these have all but died out in the private sector. Even so, some generous employers still offer final salary pensions to new joiners, including Tesco and the John Lewis Partnership (owner of John Lewis and Waitrose).
Career average schemes
In order to reduce the ongoing cost of running guaranteed pension schemes, many employers have switched from final salary to career average payouts. In other words, your pension isn't linked to the peak salary you earned in your final year, but is based on the average wage throughout your service.
Obviously, this leads to lower payouts, but hardest hit are higher-paid employees and those who received strong salary increases during their careers. Nevertheless, better an open career average scheme than a closed final salary plan.
Accrual rate
A typical final-salary scheme offers an 'accrual rate' of 1/60th. In other words, for each complete year of membership, you earn another 1/60th of your wage as a pension. So a career lasting 40 years would get you 40/60ths (two-thirds) of your final salary as your starting pension.
In some cases, accrual rates are 1/80th, so working four decades would earn you a pension worth half of your salary. However, the most generous schemes -- usually open only to directors, top executives and senior managers -- can offer accrual rates as high as 1/30th. In these schemes, just 20 years of service would earn you a guaranteed pension worth two-thirds of your final salary.
Lump sum
As well as a pension based on your income and years of membership, some final salary pension schemes -- notably in the public sector -- provide lump sums linked to your length of service.
For example, your scheme may have a pension accrual rate of 1/80th, plus 3/80ths towards a lump sum. So after 40 years, you'd get half your wage as a pension, plus 120/80ths as a lump sum, worth 1½ times your yearly salary.
These lump sums are a very valuable benefit and should never be overlooked when comparing schemes.
Retirement age
If you're lucky, your scheme will have a lower-than-average retirement age. Most private sector pensions have a normal retirement age of 65 for men and women. However, more generous schemes do allow retirement at 60 (or earlier, if due to ill health or redundancy).
In the public sector, most schemes have a normal retirement age of 60 (55 for the Armed Forces), but the Government is pushing to raise this to 65 for most of its employees.
Non-contributory
A few lucky individuals -- including members of the Armed Forces -- are members of non-contributory pension schemes. What this means is that they don't pay a penny into their pensions, as their benefits are provided solely by contributions from their employer (usually the taxpayer).
Non-contributory, final salary pension schemes are as rare as hen's teeth these days, so if you ever get the opportunity to join one, then do so without delay.
'Death in service' cover
Another valuable benefit provided by many corporate pension plans is life insurance, known as 'death in service' cover. Typically, this will give you, say, three to four times your salary if you die in service.
In most cases, your employer pays the premiums for this insurance, so it's free to you. What's more, as these policies are written 'in trust,' they are paid to a deceased employee's beneficiaries free of all taxes. So if you have this cover, then make sure your 'expression of wishes' form is up to date. Otherwise, your lump sum from life insurance could be paid to an ex-spouse, for example!
Inflation linking
Defined benefit schemes lift your pension payments each year, usually in line with inflation. While most still link to the RPI (Retail Prices Index) measure of inflation, many schemes are switching to the lower CPI (Consumer Prices Index). This means that, all else being equal, RPI-linked pensions are more valuable than CPI-linked pensions, as the RPI rises faster than the CPI.
Defined contribution schemes
Having reviewed defined benefit schemes, now let's look at their inferior alternative: defined contribution or money purchase schemes. How big these pensions get depends on four things:
- How much your employer pays in (the higher its yearly contributions, the better);
- How much you pay in (your yearly contributions);
- Your investment returns over time (the higher, the better); and
- The fund's charges (the lower, the better).
Let's briefly look at the first two factors:
Your employer's contributions
Ideally, you want your employer to be as big-hearted as possible by footing most of the bill for providing you with a retirement income.
Some generous employers pay a flat percentage of your pay into your pension, even if you don't contribute a penny. In some cases, this no-strings payment could be 10% or even 15% of your before-tax salary.
However, many employers prefer to match your contributions £1 for £1, known as 100% matching. For example, you pay in 5% of your salary and your employer pays in another 5%.
Your contributions
As well as contributing according to a "You pay X%, we pay Y%" formula, you can also make additional contributions to your workplace pension. The advantage of doing this is you get tax relief at your highest tax rate.
For a basic rate taxpayer, a £100 pension contribution costs £80, thanks to 20% tax relief. For a higher rate (40%) taxpayer, a £100 contribution costs £60. For those earning over £150,000 and thus paying 50% tax, a £100 contribution costs a mere £50.
Therefore, paying an extra, say, 5% of your wage into a pension could cost you just 4%, 3% or even 2.5% of your pay, thanks to tax relief. This explains why many people pay additional voluntary contributions (AVCs) into their occupational pensions
More on pensions:
How to retire like a Welshman
Death to over-50s life plans!
Why most pension savers lose
How to make a pensions complaint
New top pension for retirement savers!
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Comments
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As usual the comments are more interesting than the article. The problem with the "public sector" is that anything to do with salaries are skewed by people like judges and top consultants, etc rather than the thousands of nurses, dustmen, etc. Say "public sector" and people immediately think of dustmen and ignore the rest. Actually I'd much rather have a highly paid and so highly motivated judge or consultant (and the like) with a good pension than, say, a highly paid Chief Executive of Barclays Bank who has taken enormous bonuses for a fallen share price, pathetic dividends and a bank in hock to Dubai. But I accept I have a strange outlook on life.
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Aha ! And now we have it !!! JB's mask has slipped; citing the 'Taxpayers Alliance' in defence of a weak, callous, still unerringly disrespectful conviction. the Taxpayers Alliance (TA) has one aim, to reduce taxes for the wealthy by minimising public spending, no matter what harm this inflicts on the majority.; If the TA had its way, public sector workers would all be voluntary, working for nothing in order that EVEN more tax breaks could be dished out by the economically illiterate Osborne to his rich chums. As for my comments on bankers, you will have surely realised by now that I was not citing them as the only example of private sector employees (unlike your own, limited observation of the public sector), I cited the bankers as the epitome of the greed and financial incompetence that conspired to lead the UK into a recession; now it would appear the fool that is George Osborne has allowed the country to re-enter a recession with his fiscal tom-foolery and yet he still manages to reward the rich. You claim that in 2010 the private sector endured "almost" no increase in income; your sentiments are revealingly tinged with some regret; ask yourself the question then, what it feels like to be a public sector worker who for over 30 years has "endured" year after year of minimal salary increases - (I note you choose the word "income", this, of course, ignores or deliberately masks the non-income sources of financial gain enjoyed in the private sector yet denied to public sector workers). I also note you have moved on from your pre-dilection for "higher saving" being the answer to our economic ills; presumably, your empirical research which apparently reveals the aveage public sector pay in 2010 was £23,660 pa (I wish !!!) has proved the nonsense of such an idea. I ask again: are you therefore advocating higher wages in the public sector to encourage saving ? I am sorry you interpret a reasoned debate on a public commenting forum as "hectoring" et.c., well, you know what they say........'if you can't stand the heat et.c.'. Chin chin
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In reply to ECLKWRIG Bankers - I refer you to your own comment about citing examples from the higher paid end of the sector. Pay in the Public Sector – I refer you to the 2010 ONS Report on Pay. The average Public Sector figure was £23,660, whilst the Private Sector worker was found to be earning £ 21,528. The average Public Sector worker was therefore in 2010 receiving a higher salary by £2,132 pa. Also in 2010 the private sector endured almost no increase in income; once again the Public Sector led the field with an average increase of 3.8% in the three months to November 2010. Source ONS. The Final version of the Hutton Report reported on how to make all Public Sector Pensions sustainable. Refer to “The Deal” in the Hutton Report; Source HM Treasury As to respect, I have the highest respect for all those who work for a living and strive to achieve, in either the public or private sectors. Conversely; pejorative personal attacks, strident and hectoring responses to facts merely underline a poor argument that does not cover the issues at hand and is in itself disrespectful. You seem to have an interest in pensions and public spending. More information on matters financial can be found at the Taxpayers Alliance website, The Hutton Report, The ONS, UKpublicspending.co.uk and of course on here.
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05 May 2012