Those with public sector pensions (including the decision makers) do not always appreciate the value of what they have, and how different it is for those who don’t have the same benefits.
Recent headlines have highlighted something we have been saying for some time; planning and saving for retirement is not easy.
It is expected that no private sector scheme will offer the safety net of a guaranteed pension in retirement; in 1979 £9 in every £10 of all pension savings in the private sector came from guaranteed pension schemes (source Telegraph). Although some individuals may still have guaranteed pensions over time this will reduce to zero.
The last man standing is public sector pensions and yet many of those who are part of these schemes do not understand the true value of the guarantee they have.
In this blog we will consider the true worth of a guaranteed pension and how without this retirement funding is becoming ever more complex.
What is a guaranteed pension worth?
A newly qualified teacher (aged 25) and earning £22,000 would be entitled to an estimated pension of £40,338 at age 68 assuming they have no break in service (Source: Teachers Pension Scheme). This assumes no tax free lump sum but will include a spouses’ pension in retirement and pension increases.
The contribution for a starting teacher is 7.4% which is £136 p.m. gross (£109 p.m. net). (The contribution percentage rate does increase with earnings, as would the actual pension.)
The table below shows how much it would cost someone in the private sector to fund four different levels of income (including the teachers’ pension).
|Target pension in today’s terms||Inflation adjusted target pension (in addition to state pension)||Pension Fund Required||Employer Contribution (assuming 3%)||Gross Employee Contribution||Total cost|
|£17,000||£40,338||£992,374||£55 p.m.||£524 p.m. (29% of earnings)||£579 p.m.|
|£15,000||£35,150||£829,361||£55 p.m.||£428 p.m. (23% of earnings)||£483 p.m.|
|£10,000||£23,430||£531,935||£55 p.m.||£255 p.m. (14% of earnings)||£310 p.m.|
|£5,000||£11,715.00||£240,228||£55 p.m.||£85 p.m. (5% of earnings)||£140 p.m.|
This in part highlights the value of a public sector pension but equally how difficult it is for someone in the private sector to achieve an equivalent income in retirement.
If we take some “fag packet” calculations; the take home pay on a salary of £22,000 is £1,470 p.m. Assuming rent of £500 p.m. for a room and pension contributions, a teacher would have £860 p.m. left.
For a private sector worker aiming to achieve the same pension they would be left with just £550 p.m.
This crude calculation shows that value of a public sector pension could be (as a minimum) nearly £4,000 a year, or nearly £200,000 over a 40 plus year career!
The reality is that it is worth a lot more.
Education, education, education and pensions
The blame game is brilliant. Who should we blame for the demise of the golden age of pensions. Is it Gordon Brown, is it the Tories, is it poor investment performance or is it simply that we are living longer?
Most of these factors have contributed to the demise but the reality is that whether we look at the state pension or any of these schemes they were not designed for longevity. People were expected to die shortly after retiring and therefore the schemes could afford to fund the minority. Now that we are living longer that has flipped so the minority must fund the majority and the maths simply doesn’t stack up.
Even a retirement age of 68 will give 12 years plus in retirement. The reality is that perhaps we need to move to a retirement age of 75 or 85 to match what we had before. However, the thought of working for over sixty years perhaps fills people with dread.
Searching for a solution
Education is a massive part of the solution. Having a plan at 18, 21 or 25 (or event later) helps people keep focused on the end goal. But it is not just about the plan it is also about having flexible solutions.
For some time, we have been advocates of using ISAs to fund retirement. It is different because you don’t get tax relief on money coming in, but then you don’t get taxed when drawing it out.
Taking the example at the start if we were funding a pension of £40,338, this after tax would deliver a net income of £30,517. This amount would be the target under the pension ISA. If the government did something radical and enabled employers to pay in to these plans the cost would drop from £524 p.m. to £300 p.m. (16% of earnings).
Even without tax relief this is saving £120 p.m. and the added bonus is that the income at the end is tax free.
It’s still nearly three times more expensive than funding a guaranteed pension but at least it’s not nearly five times more expensive!
It is worth adding that an ISA doesn’t have the same protection as a pension (inheritance tax and not shielded from funding nursing home fees etc).
But that’s only part of the equation
Having a guaranteed pension took away a crucial part of the retirement plan. There was certainty on what we would get. These enabled individuals to focus on other goals like saving for a house.
That’s all gone now (in the private sector) and planning for retirement is as important as saving for a house or other goals we might have. With this in mind, sacrifices have to be made because there is simply not the same level of free capital in our pay packets to achieve all our goals.
There are many challenges and although the idea of a pension ISA is great it is not looking at the crux of the problem. Those with public sector pensions (including the decision makers) do not always appreciate the value of what they have, and how different it is for those who don’t have the same benefits.
At the heart of this is not only how we educate people to understand the importance of goals and setting priorities, but also accepting that to achieve even a basic level of income is now out of reach for many.
In summary rather than focusing on solutions first (which history shows is doomed to failure), the challenge is how to approach the funding for retirement now that many don’t have the luxury of a guaranteed pension. Funding for similar pension benefits is simply unaffordable for the average person, although the government is encouraging and incentivising employees to save as much as they can.
Note: This is written in a personal capacity and reflects the view of the author. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.