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Public Sector Pensions.


BGD

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Some basic information on how “Final Salary” (also known as Defined Benefit) and Money Purchase (also known as Defined Contribution) occupational pension schemes work.

 

I have to include the usual Financial Services legal “health warning” here: that this explanation is general, and is intended as basic information only; it should not under any circumstances be taken as financial advice or relied upon for investment accuracy.

 

Final Salary pension schemes in the Private Sector (ie in Companies, rather than in Government departments or Local Authorities) are almost all either closed to new members now, or completely closed down - as the costs to Employers of funding the gap between what the members were paying in and the amounts actually needed to fund all their future pensions became astronomical, and were literally bankrupting Companies.

 

 

 

The way that Company “Final Salary” based pension schemes worked is that the employee contributed "X" amount each month, as his membership fee, which bought him one-twelfth of a years worth of pensions club membership (called pensionable service), in exchange each year for the promise of being paid (usually) one-sixtieth of their "final pensionable salary, from normal retirement date.

Now, his "club membership fees" were on their own nowhere near the amount necessary, once invested, to grow enough to be able to pay out all that pension money over decades,with increases each year once in payment once he retired. The deal was that the employer undertook to pay in too, whatever balance of funding was needed for the pot to be big enough to grow fast enough to be able to fund all those promises of future pensions when they fell due.

 

The people who decide whether that total pot is big enough today, to grow fast enough in future to pay all those future liabilities are called Actuaries. They are totally independent specialist accountants, who come in normally every three years to do a fund valuation.

They take assumptions about probable investment returns in loads of different places where parts of the fund are invested, about future inflation, about future likely pay rises and, most critically, about mortality rates (the likely ages to which employees of today all different ages) will survive.

They do ALL of those calculations, when valuing any Fund, on a "Discontinuance" basis - that is, (to be as safe as possible), on the worst case scenario possible: using the assumption that the Company goes totally bust tomorrow, and no more Company or member contributions are ever made, and no more pensionable service is accrued after today's date.

All those promises of future pensions for life, based upon all those years of membership by all those members up until today’s date, and assuming all the projected future years of pay increases and inflation, when all added up, equals the current total liabilities of the scheme.

On the other side of the coin, when all the schemes invested assets, plus future likely investment growth are added together, this gives the total total asset value of the scheme.

 

Now, if total current scheme assets plus future investment returns, exceed all total future pay-out liabilities, right up to the point where that last current scheme member is projected to die, then the scheme is in "Surplus", and the only thing needed for the next period of three years is for the contributing members to keep paying their fixed monthly scheme membership fees, to keep their months and years of club membership ticking upwards.

That is a so-called "Employer contributions holiday"....there is no need at all for the Employer to put in any more money at the moment because there is more than enough in the scheme already to pay all the future pensions. The Company can thus use that money elsewhere instead: to invest in new equipment, or in new products, or extra employees, or advertising etc, to try to survive and grow commercially.

People need to be clear on this; such Employer contributions holidays ONLY happen if the employer has ALREADY paid in enough balance-of-necessary-costs monies for the scheme assets to be at this point bigger than future liabilities.

 

On the other side of the balance, poor investment returns, or people starting to live longer than previously projected, or increases in taxation on investment returns earned by the pensions scheme invested funds (and this was the massive Gordon Brown change to grab Private Sector pension funds monies to fund his expansion of the Public Sector) that killed off almost all remaining Private Sector Final salary schemes....all of these can act to mean that total assets plus future investment are currently below the total projected future amounts of money which are to be needed to pay out all pensions to all members as at today's date throughout the future until the last one dies off.

In this case the scheme is said to be presently "Under-funded".

The Employer is then legally required under the scheme rules, to turn up the "tap", the flow of it's monthly funding rate into the scheme, by an amount that the Actuaries instruct them to do, in order that any such underfunding is corrected, (normally within the next 3 years).

 

 

Now, if you can grasp all of that, you can see that the members club fees have nothing to do with the actual size of the fund; they are simply fixed as "X" percent of pensionable pay. They do not vary, whether the scheme is presently in surplus or is presently underfunded.

All they do is buy the employee years and months of membership time. Nothing more.

ALL of the investment risks in the fund are taken by the Employer ALONE.

That is why these schemes are called "Defined Benefit"....the member gets a defined proportion of whatever his final salary may be, in exchange for each year/month in which he's paid his club membership fee.

Thus he's NOT building up a personal pension investment pot (and thus taking personally all the risk of how that pot will grow by being invested in various places); instead he is GUARANTEED that Defined Benefit, ie that proportion of Final Salary as pension that he has accrued with his years and months of club membership, and it is the EMPLOYER who takes ALL the investment risk by having to turn his tap of monthly funding injections up or down as financial changes happen to investment returns, taxation, inflation etc.

The Employer HAS to do this, regardless of whether making any profits in the business or not.......which is why such schemes have literally bankrupted so many Companies, particularly as 1970's and 1980's estimations of likely future mortality rates (ages at which people are statistically likely to die) and thus associated funding rates by Companies, were woefully low: people are living much longer now than was then expected, and young people now are projected to live on average even further into their old age.

 

Thus in all such schemes the individual member isn't making any specific total financial contributions into a specific “pot”, but simply paying a monthly membership fee to earn him that month of membership time.

 

There is one key, AND ENORMOUS, difference between such Final Salary pension schemes in Private Sector Companies, and those in Central or Local Government, and other Public Sector organisations (schools, NHS, Armed Forces etc).

In Company Final Salary pension schemes there was always a real, actual, invested pot of money, kept legally entirely separate for all Company assets, which was responsible for paying out the pensions to all the members. These were called “Funded” Final Salary (or Funded Defined Benefit) pension schemes.

But in the case of the Final Salary pension schemes for most Public Sector employees, they are Unfunded. The pension that an employee “earns”) ie the promise of a future pension for them) is still based upon the length of time he has been a member of the scheme, rather than upon the actual amount of money that he and the Employer have together put into the schemes on his behalf; BUT there is NO POT (or Fund) of money building up. Hence such Public Sector Final Salary schemes are called “Unfunded”.

What happens in Unfunded Final Salary based Public Sector pension schemes is that the employees still buys time in the scheme: they have a monthly membership fee (usually a fixed percentage of gross salary) deducted from their salary, which buys them a months worth of pension scheme membership. But there is no actual money contribution into anything: the person is simply paid “X” amount less salary than they would otherwise be; they don't actually physically pay anything into any sort of pot at all. There is no money taken from them and put somewhere, they are simply paid a little less in exchange for being a member of the scheme.

Just like in Funded schemes, their promise of future pension (Benefit) will be fixed, (ie Defined Benefit)....eg “your pension at the point it begins to be paid, if paid from scheme normal retirement date, will be one-sixtieth of your Final Pensionable salary, as described in the rules of the scheme, for each year that you have by then been a member of the scheme, and one-twelfth extra on top for each complete extra month of any part year.”

This is similar to all those Final Salary schemes that there used to be in the Private Sector. But, here's the kicker: remember that there is NO INVESTMENT POT. There is simply a promise that the EMPLOYER themselves will pay out the members pension when they come to retire. Where does the Employer get the money to do that? Well as the Employer is ultimately Central Government directly, or some owned Agency of the Government (eg NHS trusts) or a Local Authority, the Employer simply uses taxes taken from other citizens and Companies, to pay those pensions every month for it's now-retired ex-employees. So Unfunded Public Sector pension schemes contain no money, they are paid for entirely from national or local Government taxation. There is no investment risk, because there is no investment....as salaries go up and as longevity in retirement increases, and such pensions in payment have the awesome advantage under their scheme rules of increases with inflation up to certain limits so the Government/Local Authority simply increase the amounts of tax on other citizens and Companies to ensure they always rake in enough to pay the increasing cost of paying all those Unfunded pensions.

 

 

 

 

 

The BIG problem with all these Public Sector Unfunded pension schemes is the massively escalating cost of them to other taxpayers.

They are (in comparison with Funded Final Salary schemes, and also Money Purchase schemes – which I'll come to in a moment) exceptionally generous in their terms.

They contain lots of incredibly expensive bells and whistles, like very young normal retirement date, big Death In Service benefits, generous widows pension, Limited Price indexation annually once in payment of up to 5 or even more percent, massive tax-free cash lump sum payment options, etc.

These got added in through decades of negotiations, as it was easy for the Employer to agree to such increases – they weren't going to have to pay them themselves, but simply add the costs to the amount of taxes that they levy on taxpayers in years to come when payment to ex-employees became due.

But even so, no-one anticipated decades ago just how many extra employees the massively increasing Public Sector was going to add to its ranks (eg the NHS is now, by a country mile, the biggest single employer in the UK); or just how much longer people were going to be living after retirement.

As a result, the costs of providing now, and the future additional costs of providing for in future, all those Public Sector employees pensions, has become utterly astronomical.

For Local Authorities alone across the UK, now on average more than 25% of the total tax revenue they gather in from Community Charge taxes, goes NOT on providing local services; not even on paying local authority employees. That 25% of all the tax they rake in goes SOLELY on paying the pensions of ex-local authority employees. And the costs, as more and more Public Sector employees are recruited, and later retire and live longer and longer, are spiralling even more rapidly.

 

 

 

 

 

The OTHER main type of occupational Pension schemes are called “Defined Contribution” (or “Money Purchase”) pension schemes.

These include all forms of personal pension, where the person simply pays in what ever they decide to each month, and also decides where bits of that pot will be invested. Then eventually when he decides to start to draw a monthly income (called an “annuity”) from that pot, the whole pot is sold to specialist annuity providers in exchange for some offer of guaranteed monthly payments.

Usually such pension payments are fixed amounts (ie once they start they do not then go up in future years with even a proportion of future price inflation), so the actual purchasing power of your pension falls year after year once it is in payment to you.

All “Defined Contribution” Company pension schemes work in the same way as those personal pension schemes. Usually what happens is that the company agrees to match, pound for pound, an employees monthly contributions, up to a certain maximum.

Thus, unlike Final Salary based schemes, where the Employer contributions vary over time as instructed by the Actuaries, there is always a Defined (fixed) amount of money going in each month, hence the name “Defined Contribution” pension schemes

All the Employer and employee contributions go into a single big pot, which is invested by the scheme administrators under the instructions of the Pension scheme Trustees.

Now, if the pot grows very fast because the investment decisions have been consistently clever (or lucky!) year after year then at the time when an individual employee comes to retire and wants to start to draw his Company pension, his share of that pot (calculated according to the scheme rules by independent administrators) will be large, and thus the monthly amount that it then pays the member will be good....but usually, unlike in most Final Salary pension schemes, it will remain fixed once in payment (as the cost to the scheme of providing for limited price indexation – yearly payment increases once the pension payout starts - is astronomical), so it's value will gradually be eaten away by price rises in the years that follow.

Also, unlike in Final Salary schemes, (and again because the costs of including it would be so massive) there is normally no residual Widows/Widowers pension included and no minimum 5 year payment guarantee: so when the member dies, no further (even reduced), payments at all are made thereafter to the members widow/widower. Death-in-Service lump sum payouts are usually much smaller than in the old Final Salary schemes, also on grounds of cost.

These schemes are often called Money Purchase schemes, because (in simple terms) what happens is that at retirement, the members sells his share of the pot of investments, and purchases an annuity (a monthly income of money) with it.....he sells off his investment pot to purchase a flow of money.

 

 

But it is vital to understand that it is the EMPLOYEE in all such Defined Contribution (“Money Purchase”) schemes, who bears ALL the investment risk.

If the big pot of invested money grows less fast, or even falls, then the rate of Employer contributions DOES NOT alter: the Company funding tap of money flowing into the fund to match those employee contributions, always remains fixed.

All that happens is that members get less monthly pension when they decide to start drawing their pension from the fund.

Thus, total monthly contributions (from employee and employer added together) ARE defined, but the eventual benefit, the pension paid out to the member, is NOT defined (not fixed, not guaranteed), as it will depend totally on the investment performance of the fund over the years, and upon what current annuity rates (the amount of pounds of value in your pension pot required to buy you each pounds worth of regular monthly payment from retirement date until the statistically averaged date upon which you are likely to die) are at that future point.

All other things being equal, the later you leave it before turning your investment pot into a monthly annuity, the bigger will be the monthly annuity that you can buy (as clearly the pot has had noe time to hopefully grow, and the annuity provider who agrees to buy your pension fund pot and give you monthly income in exchange, is likely to have to keep paying it out to you for a shorter period of time).

 

 

 

 

In the Private sector almost 70% of employees have no access to any form of occupational pension scheme; thus their only option is to take out a money-purchase Personal pension.

Of the other 30% who are working for a Company that does have a Company pension scheme, the vast majority now only have access to a Defined Contribution (Money Purchase) pension.

All employees in the Private Sector, whether in a Company scheme or not, and their Companies too, are also required by law to pay whatever taxes may be required in order to pay for the pensions of Public Sector employees.

 

In the Public Sector, almost all employees still have access to a Final Salary based pension scheme, whether it be Funded or Unfunded.

 

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HOORAY ! Pensions thread back on !!

 

Dont understand a single word of it but the endless comments and people getting upset and aggresive over 'JUST WORDS TYPED ON A FORUM' from the last thread was fantastically entertaining and fun.

 

:D

 

Guess Brucey Bruce had more time on his hands today. Maybe hes finished making his lego motorhome ??? lol

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BGD - 2011-12-14 3:38 PM

 

Some basic information on how “Final Salary” (also known as Defined Benefit) and Money Purchase (also known as Defined Contribution) occupational pension schemes work.

 

I have to include the usual Financial Services legal “health warning” here: that this explanation is general, and is intended as basic information only; it should not under any circumstances be taken as financial advice or relied upon for investment accuracy.

 

Final Salary pension schemes in the Private Sector (ie in Companies, rather than in Government departments or Local Authorities) are almost all either closed to new members now, or completely closed down - as the costs to Employers of funding the gap between what the members were paying in and the amounts actually needed to fund all their future pensions became astronomical, and were literally bankrupting Companies.

 

 

 

The way that Company “Final Salary” based pension schemes worked is that the employee contributed "X" amount each month, as his membership fee, which bought him one-twelfth of a years worth of pensions club membership (called pensionable service), in exchange each year for the promise of being paid (usually) one-sixtieth of their "final pensionable salary, from normal retirement date.

Now, his "club membership fees" were on their own nowhere near the amount necessary, once invested, to grow enough to be able to pay out all that pension money over decades,with increases each year once in payment once he retired. The deal was that the employer undertook to pay in too, whatever balance of funding was needed for the pot to be big enough to grow fast enough to be able to fund all those promises of future pensions when they fell due.

 

The people who decide whether that total pot is big enough today, to grow fast enough in future to pay all those future liabilities are called Actuaries. They are totally independent specialist accountants, who come in normally every three years to do a fund valuation.

They take assumptions about probable investment returns in loads of different places where parts of the fund are invested, about future inflation, about future likely pay rises and, most critically, about mortality rates (the likely ages to which employees of today all different ages) will survive.

They do ALL of those calculations, when valuing any Fund, on a "Discontinuance" basis - that is, (to be as safe as possible), on the worst case scenario possible: using the assumption that the Company goes totally bust tomorrow, and no more Company or member contributions are ever made, and no more pensionable service is accrued after today's date.

All those promises of future pensions for life, based upon all those years of membership by all those members up until today’s date, and assuming all the projected future years of pay increases and inflation, when all added up, equals the current total liabilities of the scheme.

On the other side of the coin, when all the schemes invested assets, plus future likely investment growth are added together, this gives the total total asset value of the scheme.

 

Now, if total current scheme assets plus future investment returns, exceed all total future pay-out liabilities, right up to the point where that last current scheme member is projected to die, then the scheme is in "Surplus", and the only thing needed for the next period of three years is for the contributing members to keep paying their fixed monthly scheme membership fees, to keep their months and years of club membership ticking upwards.

That is a so-called "Employer contributions holiday"....there is no need at all for the Employer to put in any more money at the moment because there is more than enough in the scheme already to pay all the future pensions. The Company can thus use that money elsewhere instead: to invest in new equipment, or in new products, or extra employees, or advertising etc, to try to survive and grow commercially.

People need to be clear on this; such Employer contributions holidays ONLY happen if the employer has ALREADY paid in enough balance-of-necessary-costs monies for the scheme assets to be at this point bigger than future liabilities.

 

On the other side of the balance, poor investment returns, or people starting to live longer than previously projected, or increases in taxation on investment returns earned by the pensions scheme invested funds (and this was the massive Gordon Brown change to grab Private Sector pension funds monies to fund his expansion of the Public Sector) that killed off almost all remaining Private Sector Final salary schemes....all of these can act to mean that total assets plus future investment are currently below the total projected future amounts of money which are to be needed to pay out all pensions to all members as at today's date throughout the future until the last one dies off.

In this case the scheme is said to be presently "Under-funded".

The Employer is then legally required under the scheme rules, to turn up the "tap", the flow of it's monthly funding rate into the scheme, by an amount that the Actuaries instruct them to do, in order that any such underfunding is corrected, (normally within the next 3 years).

 

 

Now, if you can grasp all of that, you can see that the members club fees have nothing to do with the actual size of the fund; they are simply fixed as "X" percent of pensionable pay. They do not vary, whether the scheme is presently in surplus or is presently underfunded.

All they do is buy the employee years and months of membership time. Nothing more.

ALL of the investment risks in the fund are taken by the Employer ALONE.

That is why these schemes are called "Defined Benefit"....the member gets a defined proportion of whatever his final salary may be, in exchange for each year/month in which he's paid his club membership fee.

Thus he's NOT building up a personal pension investment pot (and thus taking personally all the risk of how that pot will grow by being invested in various places); instead he is GUARANTEED that Defined Benefit, ie that proportion of Final Salary as pension that he has accrued with his years and months of club membership, and it is the EMPLOYER who takes ALL the investment risk by having to turn his tap of monthly funding injections up or down as financial changes happen to investment returns, taxation, inflation etc.

The Employer HAS to do this, regardless of whether making any profits in the business or not.......which is why such schemes have literally bankrupted so many Companies, particularly as 1970's and 1980's estimations of likely future mortality rates (ages at which people are statistically likely to die) and thus associated funding rates by Companies, were woefully low: people are living much longer now than was then expected, and young people now are projected to live on average even further into their old age.

 

Thus in all such schemes the individual member isn't making any specific total financial contributions into a specific “pot”, but simply paying a monthly membership fee to earn him that month of membership time.

 

There is one key, AND ENORMOUS, difference between such Final Salary pension schemes in Private Sector Companies, and those in Central or Local Government, and other Public Sector organisations (schools, NHS, Armed Forces etc).

In Company Final Salary pension schemes there was always a real, actual, invested pot of money, kept legally entirely separate for all Company assets, which was responsible for paying out the pensions to all the members. These were called “Funded” Final Salary (or Funded Defined Benefit) pension schemes.

But in the case of the Final Salary pension schemes for most Public Sector employees, they are Unfunded. The pension that an employee “earns”) ie the promise of a future pension for them) is still based upon the length of time he has been a member of the scheme, rather than upon the actual amount of money that he and the Employer have together put into the schemes on his behalf; BUT there is NO POT (or Fund) of money building up. Hence such Public Sector Final Salary schemes are called “Unfunded”.

What happens in Unfunded Final Salary based Public Sector pension schemes is that the employees still buys time in the scheme: they have a monthly membership fee (usually a fixed percentage of gross salary) deducted from their salary, which buys them a months worth of pension scheme membership. But there is no actual money contribution into anything: the person is simply paid “X” amount less salary than they would otherwise be; they don't actually physically pay anything into any sort of pot at all. There is no money taken from them and put somewhere, they are simply paid a little less in exchange for being a member of the scheme.

Just like in Funded schemes, their promise of future pension (Benefit) will be fixed, (ie Defined Benefit)....eg “your pension at the point it begins to be paid, if paid from scheme normal retirement date, will be one-sixtieth of your Final Pensionable salary, as described in the rules of the scheme, for each year that you have by then been a member of the scheme, and one-twelfth extra on top for each complete extra month of any part year.”

This is similar to all those Final Salary schemes that there used to be in the Private Sector. But, here's the kicker: remember that there is NO INVESTMENT POT. There is simply a promise that the EMPLOYER themselves will pay out the members pension when they come to retire. Where does the Employer get the money to do that? Well as the Employer is ultimately Central Government directly, or some owned Agency of the Government (eg NHS trusts) or a Local Authority, the Employer simply uses taxes taken from other citizens and Companies, to pay those pensions every month for it's now-retired ex-employees. So Unfunded Public Sector pension schemes contain no money, they are paid for entirely from national or local Government taxation. There is no investment risk, because there is no investment....as salaries go up and as longevity in retirement increases, and such pensions in payment have the awesome advantage under their scheme rules of increases with inflation up to certain limits so the Government/Local Authority simply increase the amounts of tax on other citizens and Companies to ensure they always rake in enough to pay the increasing cost of paying all those Unfunded pensions.

 

 

 

 

 

The BIG problem with all these Public Sector Unfunded pension schemes is the massively escalating cost of them to other taxpayers.

They are (in comparison with Funded Final Salary schemes, and also Money Purchase schemes – which I'll come to in a moment) exceptionally generous in their terms.

They contain lots of incredibly expensive bells and whistles, like very young normal retirement date, big Death In Service benefits, generous widows pension, Limited Price indexation annually once in payment of up to 5 or even more percent, massive tax-free cash lump sum payment options, etc.

These got added in through decades of negotiations, as it was easy for the Employer to agree to such increases – they weren't going to have to pay them themselves, but simply add the costs to the amount of taxes that they levy on taxpayers in years to come when payment to ex-employees became due.

But even so, no-one anticipated decades ago just how many extra employees the massively increasing Public Sector was going to add to its ranks (eg the NHS is now, by a country mile, the biggest single employer in the UK); or just how much longer people were going to be living after retirement.

As a result, the costs of providing now, and the future additional costs of providing for in future, all those Public Sector employees pensions, has become utterly astronomical.

For Local Authorities alone across the UK, now on average more than 25% of the total tax revenue they gather in from Community Charge taxes, goes NOT on providing local services; not even on paying local authority employees. That 25% of all the tax they rake in goes SOLELY on paying the pensions of ex-local authority employees. And the costs, as more and more Public Sector employees are recruited, and later retire and live longer and longer, are spiralling even more rapidly.

 

 

 

 

 

The OTHER main type of occupational Pension schemes are called “Defined Contribution” (or “Money Purchase”) pension schemes.

These include all forms of personal pension, where the person simply pays in what ever they decide to each month, and also decides where bits of that pot will be invested. Then eventually when he decides to start to draw a monthly income (called an “annuity”) from that pot, the whole pot is sold to specialist annuity providers in exchange for some offer of guaranteed monthly payments.

Usually such pension payments are fixed amounts (ie once they start they do not then go up in future years with even a proportion of future price inflation), so the actual purchasing power of your pension falls year after year once it is in payment to you.

All “Defined Contribution” Company pension schemes work in the same way as those personal pension schemes. Usually what happens is that the company agrees to match, pound for pound, an employees monthly contributions, up to a certain maximum.

Thus, unlike Final Salary based schemes, where the Employer contributions vary over time as instructed by the Actuaries, there is always a Defined (fixed) amount of money going in each month, hence the name “Defined Contribution” pension schemes

All the Employer and employee contributions go into a single big pot, which is invested by the scheme administrators under the instructions of the Pension scheme Trustees.

Now, if the pot grows very fast because the investment decisions have been consistently clever (or lucky!) year after year then at the time when an individual employee comes to retire and wants to start to draw his Company pension, his share of that pot (calculated according to the scheme rules by independent administrators) will be large, and thus the monthly amount that it then pays the member will be good....but usually, unlike in most Final Salary pension schemes, it will remain fixed once in payment (as the cost to the scheme of providing for limited price indexation – yearly payment increases once the pension payout starts - is astronomical), so it's value will gradually be eaten away by price rises in the years that follow.

Also, unlike in Final Salary schemes, (and again because the costs of including it would be so massive) there is normally no residual Widows/Widowers pension included and no minimum 5 year payment guarantee: so when the member dies, no further (even reduced), payments at all are made thereafter to the members widow/widower. Death-in-Service lump sum payouts are usually much smaller than in the old Final Salary schemes, also on grounds of cost.

These schemes are often called Money Purchase schemes, because (in simple terms) what happens is that at retirement, the members sells his share of the pot of investments, and purchases an annuity (a monthly income of money) with it.....he sells off his investment pot to purchase a flow of money.

 

 

But it is vital to understand that it is the EMPLOYEE in all such Defined Contribution (“Money Purchase”) schemes, who bears ALL the investment risk.

If the big pot of invested money grows less fast, or even falls, then the rate of Employer contributions DOES NOT alter: the Company funding tap of money flowing into the fund to match those employee contributions, always remains fixed.

All that happens is that members get less monthly pension when they decide to start drawing their pension from the fund.

Thus, total monthly contributions (from employee and employer added together) ARE defined, but the eventual benefit, the pension paid out to the member, is NOT defined (not fixed, not guaranteed), as it will depend totally on the investment performance of the fund over the years, and upon what current annuity rates (the amount of pounds of value in your pension pot required to buy you each pounds worth of regular monthly payment from retirement date until the statistically averaged date upon which you are likely to die) are at that future point.

All other things being equal, the later you leave it before turning your investment pot into a monthly annuity, the bigger will be the monthly annuity that you can buy (as clearly the pot has had noe time to hopefully grow, and the annuity provider who agrees to buy your pension fund pot and give you monthly income in exchange, is likely to have to keep paying it out to you for a shorter period of time).

 

 

 

 

In the Private sector almost 70% of employees have no access to any form of occupational pension scheme; thus their only option is to take out a money-purchase Personal pension.

Of the other 30% who are working for a Company that does have a Company pension scheme, the vast majority now only have access to a Defined Contribution (Money Purchase) pension.

All employees in the Private Sector, whether in a Company scheme or not, and their Companies too, are also required by law to pay whatever taxes may be required in order to pay for the pensions of Public Sector employees.

 

In the Public Sector, almost all employees still have access to a Final Salary based pension scheme, whether it be Funded or Unfunded.

Is the above post from your own head or is it copied and pasted from eleswhere, wherever its from its an assault on the eyeballs.

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Colin Leake - 2011-12-14 9:15 PM

 

All right BGD I declare you to be the winner with the longest ever post.

 

My eldest son is an Actuary. Not an easy profession to qualify for and get into but b----y well paid and the job tends to be long lasting with good pensions.

 

 

 

 

 

Colin - as you say, now a fantastically well paid job.

Possibly the most boring on the entire planet however.

 

There was a joke going around many moons ago in Business Management circles: if accountancy really is too racy for you, then you become an Actuary.

 

Ultimately the joke has backfired as these people get paid enormous sums to number-crunch life expectancy, risk, and mortality statistics.

 

Horses for courses I guess.

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Bruce’s post is accurate, factual and is only long because it reflects the complexity of pensions. Anyone who is in a scheme would do well to read it.

 

No disrespect to your son Colin - but having dealt with Actuaries virtually all my life I have to say they make accountants look positively lively, life and soul of the party types. Must be something to do with actuaries working out when we are all going to die (on average or course)

 

Best description of an Actuary I heard was that their personalities are such that they can light up a room just by leaving it.

 

 

 

 

 

:-D

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Hi Clive

 

brill reply in my humble opinion. I do think that forums should be funny as well as informative. Also that SOME people take forums FAR TOO seriously.

Not being a very well educated person myself I was unsure what an Actuary was ! However sounds like they could be well useful in the bookmakers as my horses always seem to either appear to or do die after the race commences - if I had prior knowledge of this the bet could be invested in wine to aid our training for the next Olyimpics (see Oylimpics thread)

Also maybe a motorhome / camping use ?? If I could predict when the batteries in our tourch were 'to die' would be helpful returning from the pub ?

When you think about it the predictions could be so useful and maybe justify 50 years sitting in front of a computor going blind looking at what I initially thought were useless / mindless figures ?

Anyone any other ideas of how useful this profession could by to us Motor Homies ?

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When my son was at school we never new what an actuary was until his maths teacher told him."You'd make a good teacher or a rich actuary".

 

Actually most of the calculations are done by computers and the top earners spend more time networking, talking to big firms looking for business and doing presentations to them. It's a very high powered job.

 

He sends his two daughters to two of the best private schools so that he can network with two sets of influential parents. The sad thing is that the tactic actually works. He tells me that the money he makes from this pays the girls fees many times over.

 

His brother does much the same thing as a consultant IT system architect for many of the big banks including the Bank of England. That's quite well rewarded as well to say the least!

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knight of the road - 2011-12-14 5:12 PM

 

BGD - 2011-12-14 3:38 PM

 

Some basic information on how “Final Salary” (also known as Defined Benefit) and Money Purchase (also known as Defined Contribution) occupational pension schemes work.

 

I have to include the usual Financial Services legal “health warning” here: that this explanation is general, and is intended as basic information only; it should not under any circumstances be taken as financial advice or relied upon for investment accuracy.

 

Final Salary pension schemes in the Private Sector (ie in Companies, rather than in Government departments or Local Authorities) are almost all either closed to new members now, or completely closed down - as the costs to Employers of funding the gap between what the members were paying in and the amounts actually needed to fund all their future pensions became astronomical, and were literally bankrupting Companies.

 

 

 

The way that Company “Final Salary” based pension schemes worked is that the employee contributed "X" amount each month, as his membership fee, which bought him one-twelfth of a years worth of pensions club membership (called pensionable service), in exchange each year for the promise of being paid (usually) one-sixtieth of their "final pensionable salary, from normal retirement date.

Now, his "club membership fees" were on their own nowhere near the amount necessary, once invested, to grow enough to be able to pay out all that pension money over decades,with increases each year once in payment once he retired. The deal was that the employer undertook to pay in too, whatever balance of funding was needed for the pot to be big enough to grow fast enough to be able to fund all those promises of future pensions when they fell due.

 

The people who decide whether that total pot is big enough today, to grow fast enough in future to pay all those future liabilities are called Actuaries. They are totally independent specialist accountants, who come in normally every three years to do a fund valuation.

They take assumptions about probable investment returns in loads of different places where parts of the fund are invested, about future inflation, about future likely pay rises and, most critically, about mortality rates (the likely ages to which employees of today all different ages) will survive.

They do ALL of those calculations, when valuing any Fund, on a "Discontinuance" basis - that is, (to be as safe as possible), on the worst case scenario possible: using the assumption that the Company goes totally bust tomorrow, and no more Company or member contributions are ever made, and no more pensionable service is accrued after today's date.

All those promises of future pensions for life, based upon all those years of membership by all those members up until today’s date, and assuming all the projected future years of pay increases and inflation, when all added up, equals the current total liabilities of the scheme.

On the other side of the coin, when all the schemes invested assets, plus future likely investment growth are added together, this gives the total total asset value of the scheme.

 

Now, if total current scheme assets plus future investment returns, exceed all total future pay-out liabilities, right up to the point where that last current scheme member is projected to die, then the scheme is in "Surplus", and the only thing needed for the next period of three years is for the contributing members to keep paying their fixed monthly scheme membership fees, to keep their months and years of club membership ticking upwards.

That is a so-called "Employer contributions holiday"....there is no need at all for the Employer to put in any more money at the moment because there is more than enough in the scheme already to pay all the future pensions. The Company can thus use that money elsewhere instead: to invest in new equipment, or in new products, or extra employees, or advertising etc, to try to survive and grow commercially.

People need to be clear on this; such Employer contributions holidays ONLY happen if the employer has ALREADY paid in enough balance-of-necessary-costs monies for the scheme assets to be at this point bigger than future liabilities.

 

On the other side of the balance, poor investment returns, or people starting to live longer than previously projected, or increases in taxation on investment returns earned by the pensions scheme invested funds (and this was the massive Gordon Brown change to grab Private Sector pension funds monies to fund his expansion of the Public Sector) that killed off almost all remaining Private Sector Final salary schemes....all of these can act to mean that total assets plus future investment are currently below the total projected future amounts of money which are to be needed to pay out all pensions to all members as at today's date throughout the future until the last one dies off.

In this case the scheme is said to be presently "Under-funded".

The Employer is then legally required under the scheme rules, to turn up the "tap", the flow of it's monthly funding rate into the scheme, by an amount that the Actuaries instruct them to do, in order that any such underfunding is corrected, (normally within the next 3 years).

 

 

Now, if you can grasp all of that, you can see that the members club fees have nothing to do with the actual size of the fund; they are simply fixed as "X" percent of pensionable pay. They do not vary, whether the scheme is presently in surplus or is presently underfunded.

All they do is buy the employee years and months of membership time. Nothing more.

ALL of the investment risks in the fund are taken by the Employer ALONE.

That is why these schemes are called "Defined Benefit"....the member gets a defined proportion of whatever his final salary may be, in exchange for each year/month in which he's paid his club membership fee.

Thus he's NOT building up a personal pension investment pot (and thus taking personally all the risk of how that pot will grow by being invested in various places); instead he is GUARANTEED that Defined Benefit, ie that proportion of Final Salary as pension that he has accrued with his years and months of club membership, and it is the EMPLOYER who takes ALL the investment risk by having to turn his tap of monthly funding injections up or down as financial changes happen to investment returns, taxation, inflation etc.

The Employer HAS to do this, regardless of whether making any profits in the business or not.......which is why such schemes have literally bankrupted so many Companies, particularly as 1970's and 1980's estimations of likely future mortality rates (ages at which people are statistically likely to die) and thus associated funding rates by Companies, were woefully low: people are living much longer now than was then expected, and young people now are projected to live on average even further into their old age.

 

Thus in all such schemes the individual member isn't making any specific total financial contributions into a specific “pot”, but simply paying a monthly membership fee to earn him that month of membership time.

 

There is one key, AND ENORMOUS, difference between such Final Salary pension schemes in Private Sector Companies, and those in Central or Local Government, and other Public Sector organisations (schools, NHS, Armed Forces etc).

In Company Final Salary pension schemes there was always a real, actual, invested pot of money, kept legally entirely separate for all Company assets, which was responsible for paying out the pensions to all the members. These were called “Funded” Final Salary (or Funded Defined Benefit) pension schemes.

But in the case of the Final Salary pension schemes for most Public Sector employees, they are Unfunded. The pension that an employee “earns”) ie the promise of a future pension for them) is still based upon the length of time he has been a member of the scheme, rather than upon the actual amount of money that he and the Employer have together put into the schemes on his behalf; BUT there is NO POT (or Fund) of money building up. Hence such Public Sector Final Salary schemes are called “Unfunded”.

What happens in Unfunded Final Salary based Public Sector pension schemes is that the employees still buys time in the scheme: they have a monthly membership fee (usually a fixed percentage of gross salary) deducted from their salary, which buys them a months worth of pension scheme membership. But there is no actual money contribution into anything: the person is simply paid “X” amount less salary than they would otherwise be; they don't actually physically pay anything into any sort of pot at all. There is no money taken from them and put somewhere, they are simply paid a little less in exchange for being a member of the scheme.

Just like in Funded schemes, their promise of future pension (Benefit) will be fixed, (ie Defined Benefit)....eg “your pension at the point it begins to be paid, if paid from scheme normal retirement date, will be one-sixtieth of your Final Pensionable salary, as described in the rules of the scheme, for each year that you have by then been a member of the scheme, and one-twelfth extra on top for each complete extra month of any part year.”

This is similar to all those Final Salary schemes that there used to be in the Private Sector. But, here's the kicker: remember that there is NO INVESTMENT POT. There is simply a promise that the EMPLOYER themselves will pay out the members pension when they come to retire. Where does the Employer get the money to do that? Well as the Employer is ultimately Central Government directly, or some owned Agency of the Government (eg NHS trusts) or a Local Authority, the Employer simply uses taxes taken from other citizens and Companies, to pay those pensions every month for it's now-retired ex-employees. So Unfunded Public Sector pension schemes contain no money, they are paid for entirely from national or local Government taxation. There is no investment risk, because there is no investment....as salaries go up and as longevity in retirement increases, and such pensions in payment have the awesome advantage under their scheme rules of increases with inflation up to certain limits so the Government/Local Authority simply increase the amounts of tax on other citizens and Companies to ensure they always rake in enough to pay the increasing cost of paying all those Unfunded pensions.

 

 

 

 

 

The BIG problem with all these Public Sector Unfunded pension schemes is the massively escalating cost of them to other taxpayers.

They are (in comparison with Funded Final Salary schemes, and also Money Purchase schemes – which I'll come to in a moment) exceptionally generous in their terms.

They contain lots of incredibly expensive bells and whistles, like very young normal retirement date, big Death In Service benefits, generous widows pension, Limited Price indexation annually once in payment of up to 5 or even more percent, massive tax-free cash lump sum payment options, etc.

These got added in through decades of negotiations, as it was easy for the Employer to agree to such increases – they weren't going to have to pay them themselves, but simply add the costs to the amount of taxes that they levy on taxpayers in years to come when payment to ex-employees became due.

But even so, no-one anticipated decades ago just how many extra employees the massively increasing Public Sector was going to add to its ranks (eg the NHS is now, by a country mile, the biggest single employer in the UK); or just how much longer people were going to be living after retirement.

As a result, the costs of providing now, and the future additional costs of providing for in future, all those Public Sector employees pensions, has become utterly astronomical.

For Local Authorities alone across the UK, now on average more than 25% of the total tax revenue they gather in from Community Charge taxes, goes NOT on providing local services; not even on paying local authority employees. That 25% of all the tax they rake in goes SOLELY on paying the pensions of ex-local authority employees. And the costs, as more and more Public Sector employees are recruited, and later retire and live longer and longer, are spiralling even more rapidly.

 

 

 

 

 

The OTHER main type of occupational Pension schemes are called “Defined Contribution” (or “Money Purchase”) pension schemes.

These include all forms of personal pension, where the person simply pays in what ever they decide to each month, and also decides where bits of that pot will be invested. Then eventually when he decides to start to draw a monthly income (called an “annuity”) from that pot, the whole pot is sold to specialist annuity providers in exchange for some offer of guaranteed monthly payments.

Usually such pension payments are fixed amounts (ie once they start they do not then go up in future years with even a proportion of future price inflation), so the actual purchasing power of your pension falls year after year once it is in payment to you.

All “Defined Contribution” Company pension schemes work in the same way as those personal pension schemes. Usually what happens is that the company agrees to match, pound for pound, an employees monthly contributions, up to a certain maximum.

Thus, unlike Final Salary based schemes, where the Employer contributions vary over time as instructed by the Actuaries, there is always a Defined (fixed) amount of money going in each month, hence the name “Defined Contribution” pension schemes

All the Employer and employee contributions go into a single big pot, which is invested by the scheme administrators under the instructions of the Pension scheme Trustees.

Now, if the pot grows very fast because the investment decisions have been consistently clever (or lucky!) year after year then at the time when an individual employee comes to retire and wants to start to draw his Company pension, his share of that pot (calculated according to the scheme rules by independent administrators) will be large, and thus the monthly amount that it then pays the member will be good....but usually, unlike in most Final Salary pension schemes, it will remain fixed once in payment (as the cost to the scheme of providing for limited price indexation – yearly payment increases once the pension payout starts - is astronomical), so it's value will gradually be eaten away by price rises in the years that follow.

Also, unlike in Final Salary schemes, (and again because the costs of including it would be so massive) there is normally no residual Widows/Widowers pension included and no minimum 5 year payment guarantee: so when the member dies, no further (even reduced), payments at all are made thereafter to the members widow/widower. Death-in-Service lump sum payouts are usually much smaller than in the old Final Salary schemes, also on grounds of cost.

These schemes are often called Money Purchase schemes, because (in simple terms) what happens is that at retirement, the members sells his share of the pot of investments, and purchases an annuity (a monthly income of money) with it.....he sells off his investment pot to purchase a flow of money.

 

 

But it is vital to understand that it is the EMPLOYEE in all such Defined Contribution (“Money Purchase”) schemes, who bears ALL the investment risk.

If the big pot of invested money grows less fast, or even falls, then the rate of Employer contributions DOES NOT alter: the Company funding tap of money flowing into the fund to match those employee contributions, always remains fixed.

All that happens is that members get less monthly pension when they decide to start drawing their pension from the fund.

Thus, total monthly contributions (from employee and employer added together) ARE defined, but the eventual benefit, the pension paid out to the member, is NOT defined (not fixed, not guaranteed), as it will depend totally on the investment performance of the fund over the years, and upon what current annuity rates (the amount of pounds of value in your pension pot required to buy you each pounds worth of regular monthly payment from retirement date until the statistically averaged date upon which you are likely to die) are at that future point.

All other things being equal, the later you leave it before turning your investment pot into a monthly annuity, the bigger will be the monthly annuity that you can buy (as clearly the pot has had noe time to hopefully grow, and the annuity provider who agrees to buy your pension fund pot and give you monthly income in exchange, is likely to have to keep paying it out to you for a shorter period of time).

 

 

 

 

In the Private sector almost 70% of employees have no access to any form of occupational pension scheme; thus their only option is to take out a money-purchase Personal pension.

Of the other 30% who are working for a Company that does have a Company pension scheme, the vast majority now only have access to a Defined Contribution (Money Purchase) pension.

All employees in the Private Sector, whether in a Company scheme or not, and their Companies too, are also required by law to pay whatever taxes may be required in order to pay for the pensions of Public Sector employees.

 

In the Public Sector, almost all employees still have access to a Final Salary based pension scheme, whether it be Funded or Unfunded.

Is the above post from your own head or is it copied and pasted from eleswhere, wherever its from its an assault on the eyeballs.

Your right Malc, copy and paste, thinks it is called major Plagiarism. Spanish huh 8o| 8o|
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