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What makes a good salary-related scheme?
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 pension schemes can offer different benefits in addition to the member's regular pension payment, 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.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 remain a member following auto-enrolment or to join. Being a member of 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 than 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 older schemes to new members or future accrual by existing members, replacing them with other schemes. Some schemes give you only a limited chance to join, so if you do not join when you start your job you cannot join later (although if you are eligible under auto-enrolment rules you must be enrolled, and if you opt out but are still eligible the employer will re-enrol you again three years later). Some may give you a longer period to make up your mind about joining a particular scheme, but you still need to watch this. Some schemes may not let young people or those on low pay join.
What is the accrual rate?
The accrual rate is the rate at which your salary-related pension builds up each year in a defined benefit (DB) scheme The commonest rate is 1/80th, so anything above this (say 1/60th or 1/50th) is good, and anything lower than this (say 1/100th) 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 1/100th. Other schemes have capped the level of salary on which pension rights are calculated.
What is the contribution rate? (i.e. How much you will have to pay, and how much your employer will put in?)
With a DB scheme, the employee's contribution is generally fixed, though it 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 – i.e., 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. As a rule of thumb, between 6% and 8% is a reasonable employee contribution for a quality DB pension scheme. To justify more than this, a scheme would either need to be generous or a situation exist where the workforce agrees to increase contributions to preserve a scheme in difficulties (which may be well worth doing).
The full cost of providing good quality benefits is likely to be between 25% and 30% of the wage bill, so if the employee contribution is 6%, then it’s likely your employer will be paying between 19% and 24%.
What counts as pensionable pay?
This depends entirely on the rules of your scheme, although for an auto-enrolment scheme there is a legal definition of qualifying earnings that can be made up of salary, wages, commission, bonuses, overtime, statutory sick pay, statutory maternity pay, ordinary or additional statutory paternity pay, and statutory adoption pay. That may be different from the definition of pensionable pay in schemes not being used for auto-enrolment (which may have been limited to only basic pay). The member guide to your scheme should make it clear what definition is being used.
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? However, many schemes do better than these legal minimums.
What about early retirement?
Depending on your scheme rules, you may be allowed to draw your pension early. In general, 55 is the minimum pension age, though there are some exceptions.
Can I take a lump sum when I retire?
Most pension schemes let you take a lump sum when you retire or claim your pension, in return for a reduction in your remaining pension entitlement. In other words, you exchange part of your pension for cash upfront. This is called 'commuting' your pension.
Tax rules prevent the lump sum being more than 25% of the value of your total pension value, measured using factors set by HMRC. However there may be other circumstances where pension rights of limited value can be taken as cash. The Pensions Advisory Service explains.
What if I have to retire due to ill health?
Scheme rules vary considerably on what benefits are available on ill health retirement, so you may need to check yours with your pension provider.
What are the 'death in service' benefits?
Most schemes have some kind of 'death in service' benefit which is made up of a lump sum and a pension for a spouse or partner. A lump sum of three times earnings and a half pension for a surviving partner is probably the most usual level. The Pensions Regulator has information about this.
How much will my pension increase each year when I have retired?
You should expect your pension to be increased each year after you retire. There are some legal requirements but your pension scheme rules may provide for better increases than the legal minimum.
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 defined benefit (DB) 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.