Final salary pension closing dilemma
|Retirement | Occupational Pension
Asked by JOHNSM, submitted
31 May 2010.
I would be most grateful if you could advise me on my pensions dilemma. I am 56 years old (February 2010),and married. My final salary scheme closes on the first of July. The employer has offered to contribute 12% of my salary to a new ABRSP if I were to contribute 6%. I have to make a decisions on:
a) should I contribute to the new pension scheme, and which Investments Funds should I choose? (I am a stock market analfabet, and have already suffered losses by paying AVC to Equitable Life)
b) remain contracted out or choose to be contracted in?
c) should I remain in SMART Pensions?
The pension provider will be Legal and General.The choice of investments are: the Default Lifestyle Profile, NBCY,NEDY,NRJY,NEMY,NBYY,EABY,EAEY,NEBY,NENY,LMHY and available on request Investment Fund booklet with a full list of investment fund options.
Answered by Justin on 01 June 2010
With final salary pensions a dying breed and economic turmoil likely to accelerate their demise I think more and more people will increasingly find themselves in your position, so thanks for a very topical question.
It looks like your employer is offering a Legal & General stakeholder pension to replace your existing final salary pension for ongoing contributions (I’m afraid I don’t know what ‘ABRSP’ stands for – although I’m guessing SP = stakeholder pension).
Should you contribute? If you can afford the 6% employee contribution then almost certainly yes, else you’ll lose out on your employer’s 12% contribution. Of course, if your employer is happy to give you a 12% pay rise instead then there’s an argument to consider taking this due to the greater flexibility it offers (albeit with less tax efficiency), but I’m guessing this option isn’t on the cards.
If you’re a higher rate taxpayer then bear in mind there’s a chance the tax relief on your contributions will fall from higher to basic rate at some point in future (or possibly now if you’re earning £130,000 or more a year), depending on what the Government eventually decides, but don’t let that affect your decision now. It’s a bridge to be crossed in future if we ever get to it.
As for what fund(s) you should choose I’m afraid I can’t reconcile the codes you’ve mentioned with actual funds as L&G doesn’t include these in its literature. However, it’s likely the funds available to you are as per its standard stakeholder pension, so I’ll work on that basis (you can correct me if wrong using a comment below and I’ll re-appraise).
If you’re planning to retire in the next 10 years I’d be reticent to suggest much, if any, stockmarket exposure. The key benefit of contributing into this pension will be the 12% employer contribution and tax relief on your own contribution. There seems little reason to risk these benefits at this stage in your life by gambling on higher risk investments. In your shoes I’d be tempted to use the cash and fixed interest funds. Maybe consider the distribution fund, which invests in stockmarkets, fixed interest and property, if you’re comfortable taking a bit more risk, but in the current climate I’d favour cash as your core holding.
A SMART pension, more commonly known as salary sacrifice, offers an especially tax-efficient way for employees to contribute into a pension, provided their employer plays ball.
It works by your employer making payments directly into the pension on your behalf and reducing your salary accordingly.
For example, if you earn £50,000 and agree to a £5,000 pension contribution then your employer will reduce your salary to £45,000 and make the pension contribution. Doing so avoids both employer and employee National Insurance Contributions on the £5,000 pension contribution. So you save NI (currently 11% on earnings between £110 - £880 per week but only 1% above that) and income tax (effectively the same as pension contribution tax relief) and will further benefit if your employer shares their NI saving (12.8% on earnings above £110 per week), either in part or full.
Salary sacrifice can be especially attractive for those earning just over £100,000 per year, as bringing their salary back below £100,000 reclaims their personal income tax allowance that would otherwise have been lost (it reduces by £1 for every £2 you earn over £100,000).
However, while salary sacrifice is generally a good idea for many employees, be aware that it could affect earnings related benefits such as life cover provided by your employer and the state second pension (S2P). The former can be overcome provided your employer uses your non-sacrifice salary (often called ‘reference salary’) when calculating cover and the latter if you contract out of S2P, although S2P will only currently be affected if your earnings are between £5,044 and £40,040 a year.
Should you remain contracted out of S2P? It’s nigh on impossible to make a sensible decision because we don’t know if/how governments will change S2P in future (they have a habit of doing so – in any case the state pension retirement age is due to increase). Contracting out involves investment risk (as, unlike your final salary scheme, your employer isn’t obliged to ensure you receive benefits broadly in line with S2P), but contracting in involves the risk that a government, current or future, will meddle with the system and reduce your benefit.
The consensus seems to be that someone of your age should probably contact in, but I must stress this is a very inexact science and, depending on your income level, the appeal of contracting out could increase if you use salary sacrifice for pension contributions.
Hope this points you in the right direction and best wishes whatever you decide.
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Readers' Comments (8) - To post a comment please register or login
Comment by JOHNSM at 8:18pm on 02 Jun 2010:
The funds available to invest in with Legal and General are:
Legal and general Cash Fund FMC:0.20% pa
L & G Property Fund FMC;0.25% pa
L & G (PMC) Ethical Global Equity Index Fund FMC:0.25% pa
L & G (PMC)Pre-Retirement Fund FMC:0.20% pa
Furthermore,Alternative Lifestyle,Global Equity Market Weights(30:70) 75% GBP
Currency Hedged Fund
It switches into .75% L & G Pre-Retirement Fund and 25% L & G Cash Fund
Comment by justin at 4:53pm on 03 Jun 2010:
As per my answer I'd be inclined to be quite cautious if you're planning to retire in the next 10 years (do bear mind I could be wrong and stockmarkets might surge ahead!).
On this basis the Cash and Pre-Retirement funds look like sensible options. The Pre-Retirement fund invests in gilts and high quality corporate bonds similar to those used to provide pension annuities - the idea being that if the fund falls in value this should be compensated by higher annuity rates when you retire (and vice-versa) - cheaper gilts usually means better annuity rates becase insurers can buy more gilts per £1,000 of annuity.
By all means consider the other funds too if you're more bullish about markets than me.
Comment by JOHNSM at 8:23pm on 03 Jun 2010:
Which is the better option; to invest in the Global Equity M/W (30:70) Alternative Life Style or in the L&G Pre- reteirement Fund and L&G Cash Fund?
Comment by justin at 11:05am on 07 Jun 2010:
It depends how much risk you want to take.
I believe the Global Equity Life Style option invests fully in equities if you're more than five years from retirement then gradually switches into fxed interest and cash over the final five years.
Depending on when you plan to retire you'll need to consider how comfortable you are with stockmarket exposure.
Opting for the Pre-Retirement/Cash funds is likely to be the safer option but you'll obviously lose out if stockmarkets do perform well meanwhile.
I'm afraid I can't make the decision for you as it really depends on your situation and views. But if you can afford not to take risk then playing relatively safe would seem sensible given current stockmarket volatility.
Comment by jemnetley at 2:06pm on 07 Jun 2010:
What I find very strange is that I thought it was usual for any Co winding up a scheme like this to provide free access to a pensions consultant to advise people like John on their options. If they arent John, I certainly think you should be asking your company for access to that advice and for them to pay for it as you are the one who is in effect be asked 'to take your life in your own hands' as there appears to be no risk attached to the company
To me there are some issues which I am not clear about:-
1) What is actually happening to the money invested currently in the FSS? Is that being 'ringfenced' and protected for all employees or are you being asked to take your share out of the pot and invest it? Hence your question.
2) If yes, I also seem to remember reading that it is not unusual for Co's to offer employees a ££ carrot to leave the FSS and take responsibility for thier own pension as they are the ones now taking all the risk.
2) The new stakeholder is for your new contributions. The investment decisions you take there might depend on what is happening in (1) and (2).
Comment by JOHNSM at 9:26pm on 07 Jun 2010:
My company sent us brochures with a list of investment choices, as they said "suggestions only", and when unsure which fund to choose, we ought to contact a financial adviser.
re; 1) the final salary accrued until July 2010 is protected
re; 2) from July, the pension scheme is for my new contributions, and you are right I
will be responsible for the investment decisions. It is a daunting thought.
It is a bit late for me to familiarise myself with the stock market for me to feel confident in taking the right investment moves. It is also only nine years to my retirement age (65), so not much time to learn from your own mistakes. What an optimistic fool was I for believing in all those years, that final salary closure would not happen to me.
Comment by justin at 10:21pm on 07 Jun 2010:
I guess on the bright side, if there is one, you do at least have a number of years service in a final salary scheme which leaves you better off re: pension prvision than much of the population (including me!).
With 9 years to go I'd normally suggest some stockmarket exposure along with fixed interest and cash, with a shift towards the latter as retirement beckons. But in the current climate it might be too risky. I know it's foolish to try and time markets, but sometimes the outlook appears too obvious to ignore.
If you do want to risk stockmarket exposure a plus point would be that the pension fund will be funded monthly from scratch, so the impact of any market falls shorter term will be limited (because not that much money will have been invested) and you may end up doing well if markets recover before you retire.
Comment by JOHNSM at 11:06am on 10 Jun 2010:
I have been an optimist for far too long; now is the time to get back to earth and face reality.
I will try to look at life the way that my father-in-law does, " problems makes life more interesting, they give motivation".