Am I crazy for opting out of a final salary pension?

June 8, 2007 1:00 AM

I can get a civil service pension. Yay! This could be a final salary pension. Yay! But is this really my best option? No, really, is it? Please help me understand my pension options, preferably using chocolate confectionery as a teaching aid.

In case it helps, I'm 28, single, living in rented accommodation and in the UK.

I've never really understood pensions. They just seem to consist of lots of words that don't actually relate to money, or the ability to move to Spain when I'm 50 and live the good life. No one has yet sat down an explained to me in easy to understand terms how they work.

By luck rather than judgment, I am eligible for a civil service pension (useful link: http://www.civilservice-pensions.gov.uk/). I'm not a civil servant. I've got two options, a final salary pension or a stakeholder pension. A final salary pension is A Good Thing. But... I'm on a temporary contract, until March 2008. There's a good chance it will be extended, but there's also a good chance it won't be. In any case, I don't think I'm going to be working where I'm working for a long time, a couple of years at the most.

The nice and bulky pack that arrived through my door from the Pensions people the other day seemed to suggest that I should go for the stakeholder (partnership) option if I wasn't going to be around for long (admittedly it was more understandable than some pensions information I've read). But I don't really understand why it would be better for me.

I asked our personnel department if there was the possibility of talking to a pensions adviser, there isn't, although one of them did sit down and talk through the options with me for a bit. She was seeming to suggest that the final salary one was a better option (the benefits are better). But I can't get my head around how final salary pensions work.

Oh yes, and my last employer had a very good stakeholder pension, which I had. There's now probably a couple of grand there. What do I do with that now? It's with Scottish Widows, and they're one of the options for the civil service stakeholder one. Is there a possibility I can combine the two? (I know you might not be able to answer that one at all, but I've just moved and the paperwork for my old pension is buried at the bottom of a box).

The way I see my career seems to be carving itself out, I'm probably going to end up working for a few years in one place and then moving on. I can see myself ending up with lots of little pots of money all over the place. I'm not sure that's a good thing. Oh, and the field I'm in, there's a chance I could end up working for the civil service again later in life.

It all makes my head hurt.

Here are my questions...

What is a final salary pension? Why is it A Good Thing? I think I've got my head around the stakeholder ones. (My mind works best when things are explained in real terms - "one-sixtieth of your final pensionable earnings for each year which counts as a pension" means nothing to me - "lets say you get paid 100 peanut butter kitkat chunkies a year and you work for 10 years..." is more my thing)

Should I worry about having lots of little pots of pension all over the place? Will this cause me a problem when I'm 50 and dreaming of Malaga? Should I do something about it now.

Am I crazy for opting out of a final salary pension?

Should I see an IFA? I really can't think that it would be worth their fees right now? But maybe I should...?

A few disclaimers... I know your not my financial adviser, and I'm not expecting you to tell me what to do, but I would like to have a better understanding of my options. I'm not just reon pensions to enable me to live the dream. I don't really want to move to Spain.

posted by Helga-woo to work & money (15 comments total)

The civil service final salary pension is the best deal going if you plan to stay in the civil service for any length of time. However I think you have to work for two years to come into effect. If you leave before two years are up they will just refund your contributions.

Final salary works like this:

Final salary times number of years of service divided by forty

So if you left the scheme on £20k after working for five years your pension would be:

20,000 x 5 / 40 = £2,500

So its a good deal but if you are only going to be short term a stakeholder might be better. And yes, you can transfer pensions so you should be able to bring your Scottish Widows one into your new one.
posted by ninebelow at 1:25 AM on June 8, 2007

Sorry, I've just spotted you've said 1/60, not 1/40. I have a civil service pension on 1/40 but apparently this isn't standardised.
posted by ninebelow at 1:28 AM on June 8, 2007

Motley fool's (UK) guide to pensions is useful reading. One of the fundamental choices seems to be whether you should go for general investments such as ISAs or go all out for a pension.
posted by rongorongo at 1:44 AM on June 8, 2007

I'm not sure this is either-or.

Every employee is entitled to a stakeholder pension, even if they've already got a pension. So starting one of those won't do any harm, and they're a very tax efficient way of saving. It hasn't got to be through your employer. You can do it privately.

A private pension is a waste of time and the commission involved means that they aren't as good value as a stakeholder.

I'd go and see a friendly financial advisor who works on commission. By law, he's got to tell you what the best deal for you is.
posted by humblepigeon at 1:58 AM on June 8, 2007

Another advantage of Civil Service pensions, besides the fact that they're a pretty good deal, is the fact that they're essentially bomb-proof. No government is going to want to be the government that presides over the collapse of the Civil Service pension scheme. Whatever happens, therefore, you're very likely to get your money.

I doubt any private pension could provide that sort of security.

On the other hand, ninebelow is correct - if you don't intend to stay in the CS for a fairly long time, it might be worth checking your options at your local Citizen's Advice Bureau.
posted by minifig at 2:27 AM on June 8, 2007

minifig is right - one of the key benefits of any Government pension is that it cannot go bankrupt. As others have explained a final salary pension scheme eventually pays you a proportion of your final salary - in your case 1/60th of your salary for every year worked. In contrast, a private pension scheme only pays you the profits of the money that you invested.

The final salary pension scheme should be much much better if you stay with the organisation for several years. But even if you don't you should be able to take the cash value of your contributions out and put them into another scheme. IANAPA!
posted by prentiz at 2:49 AM on June 8, 2007

The other key point about final salary is that the payout is guaranteed by the level of your salary when you leave the organisation (modulo caveats about just getting your contributions back). So the company (Government in this case) takes the investment risk.

If you are in a defined contribution system like a stakeholder, you have to figure out what level of risk vs reward you want to take, and at retirement you just get whatever annuity is available for the pot of money you've got from investing your contributions. Could be good, could be bad - the point is you take the risk and not your employer.

If it was me, I'd take the final salary unless you don't get anything back if you leave within some fixed time.
posted by crocomancer at 3:14 AM on June 8, 2007

I would take the final salary pension for just now, then if you end up leaving civil service, just transfer it into your stakeholder pension. You don't have to make a final decision right now, so I'd go with the safer bet.

If you go see an IFA, make sure they're a proper independent financial adviser - some IFA's are tied to a particular set of products, when you want a "whole of market" adviser or an entirely independent one. Wikipedia has a good summary of the differences.
posted by ukdanae at 5:43 AM on June 8, 2007

I'm not sure ninebelow has got it right above.

The civil service pension currently uses "60ths" and each year worked gives one 60th of your final salary as a pension at pensionable age (60yrs old) with a maximum of 40/60ths (i.e. 40 years service).

The cost is just 3.5% of your before tax salary.

So if you worked for 2 years to get the benefit at £20,000 salary per year, at pensionable age you would get 2/60 * 20000 = £666.67 per year for the rest of your life, indexed to keep pace with inflation. The cost would be 3.5% * 20000 = £700 per year for each of the 2 year you worked. You also get a lump sum (could be something like 1.5 times your salary from memory but not sure) at pensionable age.

Under the old scheme, ("Classic") it was 80ths but only cost 1.5% of your salary. This has not been available to new joiners for a few years.

Whatever other options exist, where else could you get such a good investment deal? Usual advice is to join the scheme. [I am not a pensions adviser, just a poor civil servant but i think its a great pension deal]
posted by muckybob at 5:49 AM on June 8, 2007

I'm not sure ninebelow has got it right above.

Yeah, I've just got my pension statement out and I have indeed inflated it. Still a good deal though.
posted by ninebelow at 5:59 AM on June 8, 2007

If you decide to go with the final salary pension, it's worth bearing in mind that you can transfer your existing Scottish Widows pension into the final salary scheme, which would buy you "extra years".

For example, you might have enough money in your existing pension to buy two extra years in the final salary scheme. This would mean that after working in the Civil Service for two years, you would have the same pension as if you had been there for four years.

Whether that's a good investment depends on whether you'd be happier with the guaranteed payouts from the Civil Service scheme, or the riskier-but-potentially-more-lucrative stakeholder scheme.
posted by roomaroo at 8:09 AM on June 8, 2007

Final salary scheme in Kit Kats

Say we pay you 60 Kit Kat chunkies per year (but not peanut butter ones - this is the Civil Service). After you retire, every year we'll give you a Kit Kat for each year you worked for us. So, if you work for us for four years, we'll give you four Kit Kats per year after you retire.

But - here's the good bit. Say in your last year working for us we promote you, and for that final year we pay you 120 Kit Kats. Then we work out your pension as if we'd been paying you that the whole time, so after you retire you get eight Kit Kats per year.

Also, we're the government and we've got a great big stack of Kit Kats, so you know we'll have plenty to give you when you retire. Other employers aren't so trustworthy and may up eating all their Kit Kats before you retire so they won't have any to give you.

--

Does that work for you? I was going to try and explain the stakeholder scheme in Kit Kats too, but the analogy started to break down. I think we'd need to move away from the Chunkies and onto the standard four-fingers to make that fly.
posted by roomaroo at 8:41 AM on June 8, 2007 [2 favorites has favorites]

Also, we're the government and we've got a great big stack of Kit Kats, so you know we'll have plenty to give you when you retire.

Not only that, but you can make more kit kats out of thin air if you need to.
posted by the christopher hundreds at 2:29 PM on June 8, 2007

Thanks for all your help, things are a lot clearer now! I think everyone has said something useful for me.

I marked crocmancer's answer as best because his point about employers taking the risk with a final salary pension was something that hadn't quite sunk in for me.

Special bonus points for roomaroo for actually using kitkats!

And sorry about my garbled last sentence, it was written in a rush; it was supposed to say that I'm not just relying on my employers pensions to enable me to live the good life, and I don't really want to move to Spain!
posted by Helga-woo at 4:32 AM on June 10, 2007

Oh, and rongorongo's link is really useful too!
posted by Helga-woo at 4:34 AM on June 10, 2007