Teachers’ Pensions - value can’t be measured in pounds and pence alone
Our Senior Pension Development and Technical Manager, Moira Warner, looks at the benefits of a defined contribution pension as an alternative to the Teachers' Pension Scheme (TPS).
Although teachers are currently likely to be focused on trying to adapt to the challenges posed by the coronavirus pandemic, their dedication regrettably doesn't alter the employer pension contribution cost challenge faced by independent schools.
Indeed, cost pressures may worsen if any schools pay fee refunds to parents. So it seems likely that many will continue to look for alternative options to TPS at this time.
Removing access to TPS is likely to be unpopular, so if teachers are to be persuaded to agree to such a contractual change, they’ll need to understand what they stand to gain, as well as what they stand to lose. No commentator would suggest that a defined contribution (DC) scheme is likely to provide benefits of equal capital value to those provided by TPS, using reasonable assumptions.
But looking at the relative merits solely from a pounds and pence perspective ignores how different sources of income can be used to support retirement planning goals. It ignores the potential opportunity value to a member of access to a DC pot. And that value lies in access to cash.
Cash without retirement
Firstly, it allows access to a lump sum from age 55 for the teacher to dispose of as they wish, without having to retire. Only those teachers with final salary benefits linked to a normal pension age (NPA) of 60 receive an automatic lump sum, and that can only be accessed on full or partial retirement. So access to cash to pay off a mortgage or help grandchildren with university fees for example, could be attractive.
Cash without pension commutation
Secondly, it allows teachers access to cash without having to exchange any of their index-linked teachers’ pension to do so.
Although NPA 60 arrangement final salary benefits come with an automatic lump sum, all others have to exchange pension income for cash. And regardless of the age at which the teacher retires, the rate they can do this at is always 12:1, meaning they'll need to give up £1 of pension for £12 of cash.
This rate doesn’t look particularly attractive, particularly for those choosing to retire early. A teacher who exchanged £1,000 of pension income for £12,000 of cash on retirement at age 60 would be giving up total pension income of £24,297, assuming annual index-linking of 2% and they lived for 20 years following retirement.
Of course, just how good or bad the 12:1 rate works out in any particular case will depend on whether the cash is invested, and whether the growth rate achieved is higher than the index-linking on the TPS pension. And of course, the cash from a DC pot won’t be entirely tax free. But if explained in a fair and balanced way, teachers could be attracted to the possibility of avoiding a poor pension commutation deal.
Cash to help facilitate early retirement
Finally, access to a DC pot complements TPS benefits and can be used to facilitate early retirement. A Freedom of Information Request made by Royal London revealed that of 2,801 retirees from independent schools in scheme year 2018/19, more than one third retired before their earliest NPA and retired with actuarially reduced benefits.
No data is available on the number of retirees with more than one NPA (for example, due to them having both final salary and career average benefits) who retired at or after their first NPA, but before their second NPA. It's likely this would make the proportion of teachers retiring early with reduced benefits much higher. For these teachers, access to a DC pot could prove invaluable in helping facilitate early retirement.
A teacher could, for example, choose to retire at their final salary NPA of 60, claiming only that portion of their benefits, and could leave their career average benefits as a deferred benefit to be claimed at their later career average NPA, using the DC pot to supplement income in the meantime.
This strategy avoids the teacher taking a potentially sizeable actuarial reduction to the pension derived from service under the career average scheme, while facilitating retirement at the preferred age. A DC pot achieves this objective in a tax-efficient way, since it can be used to provide top-up income over a limited period.
Although the defined benefit options available under TPS, such as Additional Pension or Faster Accrual can also be used to facilitate early retirement, they can’t achieve this specific objective since one way or another they provide extra pension income for life.
I’m saddened that independent schools are increasingly concluding that they have no choice but to seek out alternative options to TPS.
If arrangements must change and teachers are to be persuaded to accept that, advisers will need to help client schools set out the advantages and disadvantages of the alternative in a fair and balanced way. More importantly, an understanding of what the alternative means for teachers in practical terms will help ensure good outcomes for affected staff.