The obvious way of judging a pension is to look at how big your pension is likely to be, and compare it to the contribution you have to make.
But it's a bit more complicated than that. Different pensions can offer different benefits in addition to a basic pension, and can be more or less flexible in the choices they give members.
Of course features that are good for some people may not be useful for others. More generous benefits on top of the basic pension will cost the scheme more. If the employer is prepared to pay for these that's fine, but it's worth remembering when checking out your scheme that a generous no-frills pension might be better value for many scheme members than a less generous pension with lots of bells and whistles.
On the other hand some benefits will not cost the scheme a great deal as they cover eventualities that will only happen rarely. But if you're the one who needs them, then they are definitely worth having.
It's not always easy therefore to make direct comparisons between schemes. And of course you do not usually get a choice of schemes, simply a choice about whether to join or not to join, and almost any scheme is better than no scheme at all.
Many schemes have reduced their benefits in recent years as a way of reducing big deficits. Sometimes they have been fully negotiated. Sometimes they have been imposed. But even more employers have shut their salary related scheme to new members completely.
So if you get the chance to join a salary related scheme you are better off then the majority of the workforce.
However it's still useful to know whether your scheme is good or not, compared to other salary related schemes. Here is a list of issues to consider:
can you join it?
Many employers have closed their schemes to new members. Some schemes give you only a limited chance to join, so if you do not join when you start your job you cannot start later. Some may give a longer period to make up your mind, but you still need to watch this. Others may not let young people or those on low pay join.
what is the accrual rate? (the rate at which your pension builds up)
The commonest rate is 1/60th, so anything above this (say 1/50th or 1/40th) is very good, and anything lower than this (say 1/80th) is less good. Cutting accrual rates has been one way that schemes have tried to close deficits in recent years, so more schemes now have lower rates such as 1/80th.
what is the contribution rate? (or how much you will have to pay, and how much your employer will put in).
With a final salary scheme the employee's contribution is generally fixed, though may be varied from time to time. (With some pension funds facing difficulties in recent times, some employee contributions have increased.) The employer contribution may vary more over time as it needs to keep enough money in the scheme to cover its current and future liabilities – ie, the cost of the pensions it has to pay now and in the future.
Some schemes are non-contributory – the employers bear the whole cost of the scheme. This may be generous – or may simply mean you are getting a smaller salary than people doing similar jobs without a non-contributory scheme.
In other schemes in recent years only the employees have had to pay contributions, because the employers have taken what is known as a contributions holiday. They have been able to do this because the rise in the value of the investments (due to strong growth on the Stock Exchange in the 1990s) meant that the schemes could cover their pensions commitments without employer contributions. Whether this was sensible is another issue!
Big falls on the Stock Exchange (now partially recovered) have in turn forced some employers to start paying big contributions. That is one reason why many employers are closing final salary schemes to new members or even closing them completely.
All in all it is hard to say what are ideal contributions.
A rule of thumb is that five per cent is a reasonable employee contribution for a quality, contracted-out pension scheme. To justify more than this a scheme would either need to be generous or a situation exist where the workforce agree to increase contributions to preserve a scheme in difficulties (which may be well worth doing).
While employers' contributions will vary from year to year, over time in a fair scheme employers should contribute 2 to 2.5 times as much as employees. So if the employee contribution is 5 per cent then you should expect your employer to put between 10 and 12.5 per cent into the scheme on average over time.
Another indication of employer commitment to a salary related scheme is whether they are prepared to pay big contributions in times of difficulties without trying to close the scheme.
What counts as pensionable pay?
If some of your pay comes from bonus payments, overtime, or profit-related pay, or your pay varies in some other way, you should ask whether these factors are considered when working out your pension. If you get a straightforward salary then pensions calculations are relatively easy. However if you depend on bonuses or overtime to make up your pay then it's important these are counted when working out your pension.
Some people's pay will vary from year to year so final salary schemes may not just take the salary you are paid on the day you retire, but an average of the last few years or the best of the last few years or some combination of the two. This can be important in some jobs.
What happens if I stop work and then return?
The minimum legal requirements for maternity and other family leave are explained in How will maternity or parental leave affect my pension? but many schemes do better then these legal minimums.
Is the scheme integrated?
Integrated schemes try and target a pension level that includes State Pensions. They make a scheme harder to understand, can be unfair to those on lower salaries and can make a scheme look more generous if you don't fully understand how they work. A generous integrated scheme may be better than a mean one that isn't, but you need to be aware of the pitfalls.
Some integrated schemes pay extra before the state retirement age to make up for the fact that you are not getting a State Pension.
What about early retirement?
Sometimes employers want to encourage staff to retire early and therefore offer good terms, or they will use 'enhanced' early retirement as an alternative to redundancy.
If there are no incentives then you can probably expect a pension based on your length of service, your salary and the accrual rate as if you were retiring at the normal retirement age. It will then probably be reduced to reflect the extra cost of paying the extra years of pension you are likely to claim.
The true cost to a scheme of someone going early is about nine per cent a year. This is called the 'actuarial reduction'.
Some schemes are more generous and have a band of years where there is no reduction. For example the normal retirement age may be 65, but there may be no reduction once you are 60. Similar provision may apply to those with long service.
Schemes may not reduce your pension by the full actuarial reduction. Figures of three to six per cent are used, and clearly the lower the better.
Good schemes can have both features – a range of years where there is no reduction and small reductions for other years. However any generous treatment of early leavers is often an early casualty of measures to close funding deficits in pension schemes.
Of course if you work longer you build up a bigger pension as you will have extra years to accrue benefits and probably a bigger salary when you retire.
Can I take a lump sum when I retire?
Most pensions let you take a lump sum when you retire in return for a reduction in your pension. In other words you effectively sell part of your pension for cash up front. Tax rules prevent this being more than 1.5 times your final salary or 2.25 times your pension. The key question is how much pension you should have to give up in return for your lump sum.
This will depend on your age when you retire, and often on your gender as men and women have different life expectancies. (It is legal to discriminate in this way.) It can be hard to make direct comparisons between schemes as the pension you are giving up may be different. For example if annual increases are generous, then you would expect a bigger lump sum for giving them up.
For every £1 of pension you give up at age 65 you can roughly expect a lump sum of between £10 and £14.
The question to ask is whether an actuary has worked out fair rates for your scheme. It is possible to work these out so the pension fund is not making a profit from people taking lump sums. This needs to be done every so often, and with people living longer then you should expect a better deal.
Some suggest that many schemes have not increased the value of their lump sums to reflect the value of pension given up in this time of longer life expectancy. If this is the case - and you have no reason to think that you do not have long to live - then it makes sense to think very hard before taking up the immediate attraction of a lump sum.
What if I have to retire from ill health?
Many schemes will pay you the pension you would have got had you worked through to the normal retirement age if you have to retire early because of poor health. Other schemes may not be quite so generous, but still assume you have worked extra years.
How schemes judge whether you are too ill to continue working can vary, as can whether there is a length of time you must be a member of the scheme before you can claim.
What are the death in service benefits?
See also Will my pension support my spouse/partner/dependents when I die?.
Most schemes have some kind of death in service benefit which is made up of a lump sum and a reduced pension for a spouse or nominated beneficiary. A lump sum of three times earnings and a half pension for a surviving spouse (or beneficiary) is reasonable. Anything better is good.
What are the survivor's pensions?
See also Will my pension support my spouse/partner/dependents when I die?.
Survivor's pensions are paid if you die after retiring, and leave a partner or dependents behind. There are two things to check.
How much will my pension increase each year when I have retired?
(See also Will my pension increase once I have retired?)
You should expect your pension to be increased each year after you retire. A legal requirement on some of your pension in a contracted out scheme is that it should increase with the cost of living (RPI) up to a limit of five per cent annually.
But this requirement has been eased to 'cost of living up to 2.5 per cent' for pension built up since 2005, and also doesn't apply to some pension built up in earlier years.
So for people who have retired recently or expect to do so in the near future you should expect 'cost of living up to 5 per cent'. But those starting work today can look forward to only 'cost of living up to 2.5%' as a legal minimum. Those with some pension built up before 2005 and some after will be somewhere between the two.
Good schemes are free to beat these minimum increases, but many schemes leave increases up to the trustees of the scheme. This provides some flexibility as it can reduce the amount of funds the scheme needs to hold. If future increases are guaranteed, then the scheme must have the funds to meet them. At a time when many schemes are in deficit, this can be a difficult burden.
So it is uncommon for schemes to guarantee big increases, but it is reasonable to ask what the scheme's normal policies are.
What happens if I change my job?
Most people when they retire will have worked for a number of employers and will probably have saved for a number of different pensions.
If you leave a final salary scheme and only retire later you will receive what is known as a deferred pension. This will be worked out from your salary when you leave the scheme and your years of service in the normal way, and then uprated in some way to take account of inflation.
The law sets a complicated set of minimum standards for these increases. Most private sector schemes do no better than the legal minimum, so any improvement is an unusual bonus. If you are lucky than an ideal would be for deferred pensions to be always increased in line with the cost of living, or at least receive the same increases as the scheme's pensioners each year.
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