If you aren’t, you better join; and soon.
Where I come from opting in or out of a pension scheme was not an issue.
Making pension contributions was not discussed and having a pension, albeit in some cases a very modest one, was taken as a given.
What was an issue for me was that I never knew where the pension contribution went or exactly what the formula for calculating a pension was.
Years of service were certainly a variable. Then again, ballet dancers and army officers were allowed to retire early.
This is what excessive centralisation can lead to; still, making contributions to a pension fund – however chimeric it may be – was not even a question.
This is probably why, for me, there was never a question of not joining the pension scheme of my employer. Okay, I didn’t know the conditions of the scheme until recently, I’ll give you that; I was still in.
Years later, it turned out that many of my younger colleagues (and administrators) are not in the pension scheme. They couldn’t afford it, you see.
I already knew. I knew that a defined benefits pension scheme, with clauses for insurance and care for dependants in case something happens to you while on duty is not to be sniffed at.
I convinced some of them to join. Now they blame me for that because of the proposed changes to the pension scheme (things like capping the defined benefits part and adding the defined contribution part; but I’ll write another piece about that).
And you know what?
My junior colleagues may be disappointed with joining the university pension scheme. They are still very much better off than if they hadn’t joined.
- Because at the moment the average pension pot in Britain is a measly £30,000 and this will generate retirement income of slightly over £1,500 per year. Now, this is certainly not enough for hot-dogs dinner.
- Because this is the average and averages are very bad predictor of personal situations. I know that my pension pot is very substantial. What does this tell you about the average?
- Because it is always better to join an employer pension scheme than opt out. But here I’m running ahead of myself – in this post I set out to convince you that you should join if you are not already in.
So, let’s see how this all works (from what I understand, of course).
Yesterday, I was telling you about the UK pension reform and that it applies to a class of pensions known as ‘defined contribution pensions’.
Today, I’d like us to get to grips with a different classification: employer pension schemes and private (or personal) pension schemes.
I convinced my colleagues to join our employer’s occupational pension scheme (defined benefits scheme). They had choice.
In line with recent legislation employees have little choice in the matter. Their employer has to enrol them automatically in the pension scheme if they:
- are between 22 and the current state pension age;
- earn over £10,000 per year; and
- work in the UK.
Employers in the UK can offer two types of pensions:
- Occupational pension (defined benefits or defined contribution); and
- Personal pension (this is when the employer has no pension scheme and has to refer you to a private provider).
Apart from that, you can chose to contribute to a private (personal) pension scheme separately as a lump sum or regular contribution. With personal pension schemes – like Self Invested Personal Pension (SIPP) – you get a tax rebate in exchange for limited access.
Now, having got this one out of the way, let me get back to employer pensions and tell you why you shouldn’t opt out of them.
Main reason is of course that one day you will need income when are you not able or willing to be employed any longer. In other words, you will need income in your retirement.
This income is best to come from different sources:
- Investments;
- Cash savings;
- Businesses;
- Property and downsizing; and
- Pensions.
In an ideal world each and every one of us would have built at least three out of these five retirement income streams.
Most of us in the UK, rely on two retirement income streams: pensions and property.
And where pensions are concerned, employer pensions trump personal pensions in three important ways:
#1: You do it for reals: when you are in an employer’s pension scheme you do really contribute every month. Because you don’t see this money anyway you don’t really miss it. And the excuse ‘I can’t afford it’ can’t play any longer – you do live within your take-home pay (if you are smart and don’t want to get in debt).
#2: Your employer contributes. Yep. Your employer contributes to the pension scheme on your behalf. The level of contribution can vary dramatically. Then again, this may be one of the ways to know a good employer from a not so great one.
#3: The government contributes. Yes, you heard this right – the government contributes by allowing you tax relief on the pension contribution. In simple terms, you can pay into your pension before tax so that your taxable income is lower.
Finally…
Are you convinced yet?
Despite the change of some occupational pensions (from final benefit to final contribution) it is still very much worth it staying in your employer’s pension scheme.
And you can still aim to develop the rest of the retirement income streams as well. I am!
Great explanation!
It was my older sister who advised me to join the company pension scheme if they had one, so I did.
The thing is, I didn’t know what sort of scheme (defined benefit) it was until a few years ago when they stopped offering it to new starters.
Now, among my friends (aside from the ones I work with), I appear to be the only one on this type of scheme (not many in the private sector) so I consider myself really lucky and glad that I listened to my sis! During the days when I was in debt, I could have so easily stopped the payments but I’m glad I didn’t!
I have one friend I worked with for 12 years, who never joined, despite me trying to persuade her. Now at her latest company, she is about to opt into their defined contribution scheme and realises belatedly that she could have had 12 years locked up in our scheme prior to her leaving, which would have generated a sum that would have required a very large pot to buy an equivalent annuity.
Still at least she’s opting to join, which is better than not joining!
@Weenie: Yes, you’ve done really well to listen to your older sister. There are very few ‘defined benefits’ pension schemes left around. Whatever route people take, I believe they should build retirement income!
I am enrolled in a state retirement system plan for public school teachers. The contribution rate was 2.35% when I started teaching 18 years ago and is now 11% due to the high number of teachers retiring and not enough younger college grads entering the profession.
@Paul: Yep, there is that. Here in the UK (my pension is with the USS) our pension funds are facing crisis as well (for similar reasons). Interestingly, there have been variety of suggestions to deal with this (including capping the final benefits part and having the rest as final contribution) but no one has mentioned increasing the contribution so far. It seems to me, increased contribution may be a way to go.
Hi,
just food for thoughts…
My dad is retired from the government with a defined benefits pension plan. We took all the contributions he and his employer made on his behalf and the income it is providing today and have calculated the compound annual growth rate (cagr)… It gave a meager 3%… This is a very bad return.
Now… my dad was lucky because he could work for the same employer all his life, which will not be common in our generation. I’m 33 and I already had more than 15 different employers since I’m 16.
If you get out of the plan before retirement there are penalties… you could let the money sleep there but it’s not a bank account… I wouldn’t like to have partial pension plans with 10 different employers.
Now about defined contributions pension plans… Here in America they offer us to invest in mutual funds offered by insurance companies. It’s good to know that more than 80% of all mutual funds out there won’t even give you the market return and a lot will return you not much more than a bond. Every two or three years, the employer or insurance company will shut down some of the underperforming funds and replace them with new ones. If your money was in one of those funds then you might have to sell at a lost while waiting could have solved it all or at least you’ll lose the opportunity to average down.
I’ve been with the same employer for the past 6 years. We have both options :defined benefits and defined contributions pension plans. They have changed 3 times of providers during that time frame so we had to sell our funds and buy new ones 3 times… this is very bad! For me, the timing was not good… I lost money… So my CAGR was negative during those years while the market rose by more than 178%…
I now prefer managing money by myself. I’m tired to get screwed.
For sure, if my employer would give me 10$ for every 10$ invested, I would take it. It’s free money. But I would try to take the money out asap to manage it in a self directed retirement account.
Insurers or mutual funds providers make a lot of money with our retirement accounts and they take no risk since the return is not guaranteed. They take out 2,5% of our hard-earned money as “management” fees and give us low or negative returns…
Warren Buffett suggests to his estate to put 90% of their cash into an index fund and 10% in 5 years treasury notes. This strategy will most probably beat all the actively managed mutual funds out there and so-called pension plans. That’s what he believes and that’s what I believe too.
Just my two cents…
Thank you
@Allan: Thanks for writing this; certainly worth thinking about. I believe to a generation (and profession) where the defined benefits pension still works. About the rest – and people who are young now – you are right. Thing is: how do we encourage people to save and invest for their retirement. The stats for the UK is absolutely dire.