Many of my friends are ex-teachers, having retired from the profession. We were recently talking about how valuable the teachers’ pension scheme has been to them in building a decent amount to retire on and bemoaning the fact the next generations are unlikely to have such benefits provided through the generosity of their employers.
Our discussions were brought about following the release of a new report from Resolution Foundation,
which advocates a radical solution: transferring wealth between generations in part to kickstart pension saving among the young.
While discussing these issues, however, it became clear that many of those who have built up substantial defined benefit pensions are of the view that they paid for them themselves while at work – something that, while not impossible, was difficult to do – so why were the next generations struggling to do the same?
The worrying thing is that so many employees only see the relatively small amount of contribution they were required to make as being enough to provide the generous pensions to which they have become entitled.
A typical DB occupational scheme from the past would have aimed to provide a pension of 1/60 of an employee’s salary at or near retirement for every year of pensionable service. So, a working career of 40 years could have provided an individual with a pension of two-thirds their salary at or near retirement.
That pension would typically come with inbuilt increases each year to keep pace with inflation and would continue to a surviving spouse, usually at a reduced rate, if the pensioner were to die before them.
Such an annuity would be extremely expensive to buy for someone in their mid-60s. For someone on what many would consider modest earnings at the end of their career, the cash value of the pension accrued could easily be between £500,000 and £1m – a fantastic sum of money for most people.
Still, many members of such schemes only see the 5 or 6 per cent of annual earnings they were required to contribute as the whole cost of providing these generous benefits.
That is far from the case. A typical “sixtieths” scheme would cost the employer something like 23 to 25 per cent as an annual contribution of payroll to provide.
Yes, the 5 or 6 per cent paid directly by employees is a substantial part of that, but the lion’s share, year in and year out, has been made by their employers. It is this 17 to 20 per cent regular contribution by employers that seems to be invisible to so many employees.
So, before we start talking about things like raising taxes and giving £10,000 to younger people to help with pensions (a minuscule sum in terms of lifetime savings), we should instead examine ways to incentivise employers to make providing generous workplace pensions the norm again, not the cumbersome and out of place dinosaurs they are increasingly becoming.
Getting rid of the red tape that ties employers providing pensions in knots would be a good start.
Steve Bee is director at Jargonfree Benefits