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Pensions how do they work?

DonDaddyDDonDaddyD Posts: 12,689
edited July 2011 in Commuting chat
For reasons I cannot be bothered to explain (it as a life choice OK) I don't as of yet have a pension. I made the decision to start one when I hit 30. Well 30 looms large and there is this whole debate about public sector pensions.

So I got to thinking I actually don't understand enough or anything about pensions, it's not something I've had to think about until now.

How do they work?

(GregT, Greg66, CIB and Mr Sterry are usually good at this type of this)

Hopefully I'll get an answer before the whole "Public sector workers should be second class to Private sector workers" things rises up.
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  • bails87bails87 Posts: 13,317
    This is no help at all, but I thought you were public sector, how come you don't have a pension from work? Did you specifically opt out?
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  • SimonAHSimonAH Posts: 3,730
    Not even a pension through work or are we talking about an additional private one DDD? That really surprises me, especially as you are in the public sector as you say.
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  • rjsterryrjsterry Posts: 17,983
    A bit busy at the mo, but can post later with explanation if needed. If you are an NHS employee do you not already have one? Probably best to top this up if you can rather than starting a private pension - less tax efficient.
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  • DonDaddyDDonDaddyD Posts: 12,689
    rjsterry wrote:
    A bit busy at the mo, but can post later with explanation if needed.

    Yes, please.
    If you are an NHS employee do you not already have one? Probably best to top this up if you can rather than starting a private pension - less tax efficient.

    No I opted out.

    For everyone else the reasoning is in my original post.
    Food Chain number = 4

    A true scalp is not only overtaking someone but leaving them stopped at a set of lights. As you, who have clearly beaten the lights, pummels nothing but the open air ahead. ~ 'DondaddyD'. Player of the Unspoken Game
  • aidsoaidso Posts: 493
    Pensions for Public Sector have, until recently (?) worked based on your final salary. So if you work for 40 years and finish on a salary of £40k/year then this is what you will receive. You still get taxed on this.

    For me though, I work in the private sector and I submit 15% of my monthly salary towards a private firm. When it comes to retirement age they give me my money back plus interest and then i can BUY a pension in the region of 2-3 times what I have paid in - this figure im not 100% about.
    During my payments I can choose to get all the money back - exactly how much I paid in or, invest in something. The company will invest in housing, stock market etc so I could end up with less money or more money that I paid.

    Since I am paying 15% you can imagine I don't agree with the hoohah being kicked up from the civil servants who I see as getting a free pension. Something should change but I don't know what.
  • SketchleySketchley Posts: 4,235
    Well you pay money in, which is tax free. So if you are on 20% tax rate for every £1 you put in the tax man adds 25p. Your employer may also match your contributions which again go in tax free.

    The money you put in is then invested, who you invest this with and which fund are down to you, some are more risky than others, some have higher returns, some loose money, some are "Green". As your pension pot grows you may wish to change the way your money is invested, many people nearing retire move to less risky funds as there is no time to make up losses.

    When you retire you have a some of money. You can take 25% of this a tax free lump sum on retirement. Then you either buy an annuity from a life insurance company with the remaining amount which gives you a monthly taxable income for life or you draw down a taxable income directly from your pension pot but if it runs out it's gone.

    Not much else you really need to know. Good link http://www.direct.gov.uk/en/Pensionsand ... /index.htm

    Also take financial advice on this from a good IFA, but you may be better maximising a ISA before starting a pension.
    --
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  • hellshells Posts: 175
    Im 25 and work in the NHS and have been paying into the pension for nearly 3 years. I opted in when I joined as my dad (retired police officer) and partner (NCO in the army) said I would be crazy not to. The contributions seem pretty large to me (11% of salary) and unlike the police and army pensions you don't get a lump sum when you leave service. I didn't understand how it works then and still don't but I was under the impression that I was getting a decent deal and was doing the right thing. I am even more confused by the proposed changes and I am not certain if the pension is a good deal or now a complete and utter waste of money. When the changes become set in stone I will be finding a union rep to explain to me the ins and outs of it. At the moment I get the feeling it would be better to take the equivalent amount of money and put it into a high interest savings account. If I had never joined the service I would almost certainly be one of the private sector workers who never bothers to get a pension sorted out simply because they are not offered to opt in to one when they start work and then never think about it.
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  • Wrath RobWrath Rob Posts: 2,918
    The simplest view is that you invest money into a scheme (e.g. a bank acount, a investment trust etc) for a long time. Interest and other gains on your investment accumulates over time and by the time you come to retire you hope you've got a big pot of cash. With that put you can buy an annuity, which is a financial instrument that guarantees to pay out specific amount at fixed intervals, e.g. £15k per annum. THe bigger your pension pot, the bigger the annuity you can buy.

    The benefits of a specific pension fund compared to a bank acocunt are that its tax free to invest (or tax deductible) and the gains are all tax free (unlike interest on your bank account or property, stocks and shares that are liable to capital gains tax) but you then pay tax when the annuity pays out.

    Modern schemes allow you to take a lump sum at retirement, e.g. to pay off a mortgage, but then there is less in your pot to buy a bigger annuity.

    The best scheme is what's known as a final salary scheme. For every year you are a member of the scheme you are awared an amount of your salary when you leave the scheme. For example, most schemes award 1/60th of the salary per year. So if you work for 40 years, are earning £100k when you retire you will have a pension of 40/60ths of £100k, so £66k as your pension. This is great if you're an employee as your pension is not linked to specific contributions. Not so good if you're an employer as you carry all of the risk, i.e. if you have to pay out more than the investments the scheme as made, you have a problem. This is the pension black hole that you often here about. Due to this, most companies have closed their final salary schemes.

    Government/public sector pensions are slightly different as there are no investments made by employees, the tax payer has to fund the pension payments. Therefore if you have an ageing population who will increase the amount of tax receipts that have to be used to pay for pensions, you have a problem. Specifically we have a problem as that is the situation in the UK. Therefore if you change the scheme so that public sector employees contrinute to their pension, you decrease the future dependency on tax receipts, allowing them to be spent on other things like schools, cycle schemes etc.

    Make sense?
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  • There are two types of scheme: defined benefit (e.g. final salary) and defined contribution. As the names suggest one defines what you get out and one defines what you put in.

    In a DB scheme, it's up to your employer to make sure there's enough in the fund to pay everyone their defined benefit. If the market tanks, they have to pick up the bill. In a defined contribution scheme, all the risk is bourne by the employer. Guess which one is more popular with employers.

    Teachers, policemen, nurses etc. (not GPs) have a defined benefit scheme but it's not funded as such - pensions are paid out of current income.

    If you wanted to work for, say 40 years and retire on half your final salary, well it's uncertain but I'd reckon you'd have to be putting 15-20% of your gross salary into a DC pension. Bear in mind rules, annuity prices etc. change all the time.

    Most of us will be living on petfood in cold, lonely flats.

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  • Butterd2Butterd2 Posts: 937
    2 Different types;

    A private sector pension; You save up a pot of money (benefiting from tax allowances) and when you come to retire you buy an annuity with it. An annuity is where you go to an insurance company and say "if I give you my pot of money how much money will you guarantee to give me per month until I die?. The value of your pension will therefore depend on;
    a) how much you put into your pot
    b) how much interest your pot earns
    c) what price annuities are when you retire.

    B A public sector pension is where you pay a nominal amount of your salary into a big black hole from what I can make out. However the government promises to pay you a pension of x% of your final salary, depending upon how many years you have worked for them, upon your retirement. The difference is that when you retire you are not getting back the money you saved from you pension contributions, you pensions is being paid by other peoples current tax/NI contributions, so it is in effect a big Ponzi scheme. So long as the working population and GDP of the country keep growing all is well, should this change (Japan, Germany for example) you begin to build up a problem as you are not generating the wealth to pay you promises.

    At present public sector (or final salary) schemes are worth hugely more than a private pension and are being subsidised by the private sector. My pension from 12 years in BT (almost public sector) will be worth far more than the private sector pension I am now building up (even through I am contributing far more into it).

    You are right to be thinking about starting one now, if you leave it much longer you may as well not bother and just accept the need to work your entire life. The "pot" you need to build up for even a moderate pension is several £100k's.
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  • bails87bails87 Posts: 13,317
    edited July 2011
    aidso wrote:
    Pensions for Public Sector have, until recently (?) worked based on your final salary. So if you work for 40 years and finish on a salary of £40k/year then this is what you will receive. You still get taxed on this..
    This is wrong, for the NHS at least.

    It used to be based on the final salary, that didn't mean you got paid the final salary.

    Up until 2008 you'd get 1.25% (1/80th) of your final full year salary for every year that you were employed by the NHS

    So work for them for 20 years, finish on £40k, you get 1.25% x 20 x 40,000=£10k per year.

    It's now based on 1/60th of the highest 3 years pay out of your final 10 years employment, per year worked.
    Example 3
    A midwife retires after 28 years and 173 days pensionable membership with reckonable
    pay of £25,650.
    Her pension is
    £25,650.00 x 28 years 173 days x 1/60 = £12,172.62 per year
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  • davieseedaviesee Posts: 6,473
    A simple way of looking at it is this.

    When you pay into your pension, you are paying the pension of the current retirees.
    Once you retire you hope the then workers will pay into the pension fund so you can collect your pension.

    That theory may well work in the public sector but I saw the pitfalls in the private sector decades ago.

    If you can get into a public sector pension then that is the way to go as they are more efficient than a private pension and safer than a private sector company pension.
    None of the above should be taken seriously, and certainly not personally.
  • clarkey catclarkey cat Posts: 3,641
    they're basically the same as a bed and breakfast but on the continent
  • rjsterryrjsterry Posts: 17,983
    Looks like I don't need to now as the above covers what I was going to say, but in short, you will be surprised how much you need to put away to keep you in the manner to which you are accustomed when you retire. Do it soon, as the more money you put in earlier, the better.
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  • gtvlussogtvlusso Posts: 5,112
    edited July 2011
    DDD,

    I am going through some of the same conundrum:

    I have had private pensions since I was about 23; I am very lucky in the jobs I have worked.

    However, I now have a collection of 6 different schemes for 4 differing companies - I am unifying the schemes into 2 pots at the moment.

    As such, I have opted out of SERPS - the government led second pension scheme - my reasoning for this was that my schemes are reasonably good and governments can change legislation on their scheme whenever they want to - i.e. in a economic crisis!

    For ref - as you opted out of the NHS scheme, you will have basically given away a couple of grand a year that the NHS pay in on your behalf. As a private employee I have always had to pay a residual amount in to the scheme - allot of public schemes are non contributory - meaning that they will pay in a value without your contribution at all - i.e. free money - check with your scheme administrators.

    In terms of payouts:

    I believe that you can take 25% of the value of the cash on retirement up to £80k. However, you then have to use the rest to buy a pension or 2 or 3 times the value. The annuity (monthly amount that the scheme will pay out) can vary depending on the amount you have put in.

    Projections:

    My projected retirement fund was £3M when I started my pension. However, that has dropped to about £900k. The annuity that this buys me is about £20k per annum from what I understand - this is where public sector schemes kick private schemes arses. Anuities are completely censored , even though you have a high residual amount - hence Final salary schemes rock!

    I completely disagree with the hullaballoo that civil servents are currently kicking up about their pensions - as a private sector worker, private pensions are shocking and are contributory - allot of public sector pensions are still non-contrib. Being honest, I would put my money into a few flats and live of a rental income, I do not have the option now though.

    For the record, I am not an actuary and the information I have is probably out of date!
  • Butterd2Butterd2 Posts: 937
    DonDaddyD wrote:

    No I opted out.

    For everyone else the reasoning is in my original post.

    Don't take this the wrong way but that was not a clever decision.

    (Caveat: unless you do not plan on reaching retirement)
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  • DonDaddyDDonDaddyD Posts: 12,689
    Wrath Rob, yeah that makes sense.

    Thanks to everyone else as well.
    Food Chain number = 4

    A true scalp is not only overtaking someone but leaving them stopped at a set of lights. As you, who have clearly beaten the lights, pummels nothing but the open air ahead. ~ 'DondaddyD'. Player of the Unspoken Game
  • bails87bails87 Posts: 13,317
    gtvlusso
    The NHS scheme requires contributions from the employee.
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    "As I said last time, it won't happen again."
  • DonDaddyDDonDaddyD Posts: 12,689
    bails87 wrote:
    Example 3
    A midwife retires after 28 years and 173 days pensionable membership with reckonable
    pay of £25,650.
    Her pension is
    £25,650.00 x 28 years 173 days x 1/60 = £12,172.62 per year

    For how many years?

    And what happens to the pension contributions of current NHS workers that have been paid in already. Does that money get co-opted into the proposed new system?
    Food Chain number = 4

    A true scalp is not only overtaking someone but leaving them stopped at a set of lights. As you, who have clearly beaten the lights, pummels nothing but the open air ahead. ~ 'DondaddyD'. Player of the Unspoken Game
  • bails87bails87 Posts: 13,317
    DonDaddyD wrote:
    bails87 wrote:
    Example 3
    A midwife retires after 28 years and 173 days pensionable membership with reckonable
    pay of £25,650.
    Her pension is
    £25,650.00 x 28 years 173 days x 1/60 = £12,172.62 per year

    For how many years?

    Until death.

    http://www.nhsbsa.nhs.uk/Pensions/Docum ... uide_-_(V6)_03.2011.pdf
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    "As I said last time, it won't happen again."
  • HeadhuunterHeadhuunter Posts: 6,494
    I was always under the impression that company pension schemes were better that private options and I was definitely under the impression that public sector pensions are far better than anything you could get on the open market. My dad was a teacher. He retired before he was 55 on a full pension and does quite nicely! I on the other hand am restricted to the work stakeholder or a private option. I initially started a private stakeholder but later was told that it's better to go with the work stakeholder as you automatically get NI contributions refunded into it (or something)....

    The number of people out there without any kind of pension at all is scary though... We certainly are going to end up with a load of people on the poverty line in old age in 20 or 30 years...
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  • DonDaddyDDonDaddyD Posts: 12,689
    bails87 wrote:
    DonDaddyD wrote:
    bails87 wrote:
    Example 3
    A midwife retires after 28 years and 173 days pensionable membership with reckonable
    pay of £25,650.
    Her pension is
    £25,650.00 x 28 years 173 days x 1/60 = £12,172.62 per year

    For how many years?

    Until death.

    http://www.nhsbsa.nhs.uk/Pensions/Docum ... uide_-_(V6)_03.2011.pdf

    :shock:

    Do I have a choice about how much contributions I pay? Or is it a predetermined percentage?
    Food Chain number = 4

    A true scalp is not only overtaking someone but leaving them stopped at a set of lights. As you, who have clearly beaten the lights, pummels nothing but the open air ahead. ~ 'DondaddyD'. Player of the Unspoken Game
  • cloggsycloggsy Posts: 243
    DonDaddyD wrote:
    Pensions how do they work?

    They don't, that's the problem...

    You'd be better off putting your money into property and renting it out to build up your 'retirement fund' rather than pay into a pension IMHO!
  • DonDaddyDDonDaddyD Posts: 12,689

    The number of people out there without any kind of pension at all is scary though... We certainly are going to end up with a load of people on the poverty line in old age in 20 or 30 years...

    People are living up to 20years longer as well. It's not just pensions, it's savings of any kind that people don't have. When I was in my mid 20s (when I started working full time) I promised myself I would do the carefree spend now save later thing for 5 yrs (I also needed 5 yrs to get my 'financials' in order) and then demonstrate sensible saving from 30.

    I also needed to progress my career and increase my salary so saving actually became a realistic prospect. Saving a substantial amount and trying to live off (in London) less than and upto £1500 is nigh impossible when you're just starting independent living.
    Food Chain number = 4

    A true scalp is not only overtaking someone but leaving them stopped at a set of lights. As you, who have clearly beaten the lights, pummels nothing but the open air ahead. ~ 'DondaddyD'. Player of the Unspoken Game
  • DonDaddyDDonDaddyD Posts: 12,689
    cloggsy wrote:
    DonDaddyD wrote:
    Pensions how do they work?

    They don't, that's the problem...

    You'd be better off putting your money into property and renting it out to build up your 'retirement fund' rather than pay into a pension IMHO!

    I have other (monetary or asset driven) financial plans either in place or to be put into place.

    Pensions have always been a specific grey area for me.
    Food Chain number = 4

    A true scalp is not only overtaking someone but leaving them stopped at a set of lights. As you, who have clearly beaten the lights, pummels nothing but the open air ahead. ~ 'DondaddyD'. Player of the Unspoken Game
  • nationnation Posts: 609
    gtvlusso wrote:
    However, I now have a collection of 6 different schemes for 4 differing companies - I am unifying the schemes into 2 pots at the moment.

    I am in a similar situation and am vaguely aware that unifying pots would be a good idea, but have absolutely no idea how to go about it. Where did you go for info and advice on how to do this?
  • londonlivvylondonlivvy Posts: 644
    It always surprises me how many people don't pay into their pension. I started paying in when I was 22, on the advice of my father, so as to get the benefit of compound interest over the years and more years to build up a bigger pot.

    Also, in almost every job I've had, the employer has matched my contribution - so if I've paid 5%, they've also paid in 5%. Free money, at GTV has pointed out.

    But whilst I've got a little pot building up, I do not trust the stock market or pension companies and am concerned that I could reach 65 and end up with naff all. Friends who understand the stock market and investments generally tell me it's possible to invest more wisely and with better returns themselves than via a pension company.

    I like the bricks and mortar idea - buying flats to rent out etc - but not sure I can afford this on top of everything else.
  • londonlivvylondonlivvy Posts: 644
    nation wrote:
    gtvlusso wrote:
    However, I now have a collection of 6 different schemes for 4 differing companies - I am unifying the schemes into 2 pots at the moment.

    I am in a similar situation and am vaguely aware that unifying pots would be a good idea, but have absolutely no idea how to go about it. Where did you go for info and advice on how to do this?

    Me too. I have 6! Your work may have a pensions advisor so go and chat to them. It turns out that he advised me not to try joining them together because
    a) one is a (tiny) final salary
    b) one is a belgian one
    c) one is employer-linked
    d) others have more advantageous management fee rates, but I am not allowed to continue contributing to them.

    I think I may ignore the advice relating to d though as it's getting pretty complicated and I think that more money in teh same pot vs smaller pots has to be a better idea?
  • I was always under the impression that company pension schemes were better that private options and I was definitely under the impression that public sector pensions are far better than anything you could get on the open market...

    The reason a company scheme might be better is lower management charges because they are spread over the whole scheme. Also there's the stakeholder legislation that restricted a lot of company shcemes to a maximum charge of 1% (that's 1% of your entire pot - even if they screw up and it goes down in value) per year. Invest on your own and expect to pay a bigger AMC.

    I do still have a final salary scheme from a previous employer. They are pretty rare these days though.

    There are ways of mitigating market/annuity price risks such as phased retirement or income drawdown. Can get complicated though.
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  • W1W1 Posts: 2,636
    gtvlusso wrote:
    I would put my money into a few flats and live of a rental income, I do not have the option now though.

    Except that that isn't so tax efficient, so has to work harder/be more successful than a pension scheme in order to achieve the same result (which of course it might do). There is also the inherent risk of leveraging up using a mortgage - something I wouldn't do to a pension pot either.

    One also needs to factor in employer contributions if there are any, and then do the maths.
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