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In the scheme of things

The well-known public company at which I work is changing its pension scheme and giving me three options. What should I do?

The options are to continue but pay an extra 2 per cent, continue without the extra contribution but with your pension built up at a lower rate of 1/80ths or, instead, join a money-purchase scheme with the employer contributing up to 5 per cent of salary.

You are 58, have been employed for 28 years and expect to retire at 65. You earn around 32,000 a year. You cannot see yourself retiring before 65 or being promoted.

The good news is that, whichever route you take, the death insurance benefits will remain very similar and can be ignored for this decision.

If we ignore inflation and wage increases, a 2 per cent increase in contributions to retain the existing benefits will cost you 41.60 a month or a little under 3,500 over the next seven years after tax. The next seven years will provide an additional pension of 3,733 a year. If you drop to the lower benefit structure, then seven years will provide an additional pension of 2,800. Ignoring inflation, for a cost of 3,500, you receive an extra pension of 933 a year – a very good deal.

If we take inflation into account, then while your contribution increases over the years, your final benefit will increase more so. Using 4 per cent inflation, the benefit would increase to 4,722 in 1/60ths and 3,542 in 1/80ths – a difference of 1,180 a year.

If you choose the money-purchase arrangement, paying the maximum 5 per cent with the company matching your contribution, 3,200 a year will be paid into your pension kitty for the next seven years. Using what I believe to be a relatively optimistic forecast of an annual 7 per cent return, this still projects a pension at 65 of less than 1,500 each year. Yes, you will no longer be contracted out of the state second pension and will therefore accrue additional pension with the Government but, even if this is added to the projection, this is still significantly less than that provided by the previous two schemes. If salary inflation is included at 4 per cent a year, the pension increases to a little under 2,000 a year on a similar basis to the existing scheme.

My recommendation has to be that you stay in the existing scheme on the existing structure and pay the additional 2 per cent contribution.

The reason why your employer is making changes to the scheme revolves around all the issues that have been publicised over the last 12 months or more. The easiest problem to explain has been the collapse of investment markets worldwide. Virtually all big pension schemes based on a final salary structure are underfunded. Underfunding has been created by the collapse of investment markets and dramatic fall in the value of the pension fund.

It is your company that promises you the pension and it merely uses the pension fund as an efficient way to provide it. If your company is trading soundly, it has an obligation to meet its promise and, in this respect, you should have a few worries. With the passing of the Pension Act 2004, further protection is being introduced where companies fail, leaving a pension scheme underfunded. But it is not just the investment return that has caused the underfunding problem. There are many other factors, not least new Government regulation, taxation and accounting practices. When these factors are added to the ever increasing costs created by longer life expectancy, the promise of a pension related to final salary is a promise that fewer employees will be able to enjoy.

Interestingly, while your company has the right to cancel the scheme, it cannot get out of its promise for past benefits and it cannot make you pay more money. Therefore, you have the situation you now find yourself in, whereby you are being asked to pay more money to keep the scheme you were originally promised.

You are very pleased with your employer, you have no suspicions about its future success and you see yourself working with it until retirement. It has a financial problem in that it has made promises to employees concerning their pensions, which are now costing significantly more then it ever thought. If it is to continue with those promises, it needs more money and, quite rightly in my view, it is looking to the members to pay a little more.

You are best served by staying in the same pension scheme and paying the extra 2 per cent contribution than either of the other options.

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