In the first in a series of articles on different professions and their pension options, we examine the teachers’ pension scheme.
Long holidays are a well-known perk of the teachers’ benefit package. And, although changes have been introduced in the past few years, teachers can also take advantage of a generous pension scheme.
How does the pension scheme work?
It is a career average scheme, so members can expect to receive a pension based on their average earnings during membership of the scheme.
Each year, members earn a benefit equivalent to 1/57th of that year’s pay. To more than keep pace with inflation, this benefit is increased annually, in line with the September Consumer Prices Index plus 1.6%, applied the following April.
How much a teacher needs to pay in depends on salary, with lower-earning members paying in a smaller percentage of income. In 2016/17, a teacher earning less than £26,000 would need to pay in 7.4% of their income, while if their salary was more than £75,000, the percentage would increase to 11.7% of income.
Normal pension age on the scheme is the higher of either 65 or the state pension age, so members can expect to see this age increase, to 66 by October 2020. Members can take their pension as income or convert part of it into a lump sum.
Can you pay in more if you want to?
Teachers can buy additional pension income in multiples of £250 a year up to a maximum of £6,500 a year. How much this costs varies, with the member either paying with a lump sum or through an additional monthly deduction from their salary. They can also opt for faster accrual where they earn 1/45th, 1/50th or 1/55th of their earnings instead of 1/57th.
Alternatively, if they want to retire up to three years early, they can select buy out. This must be selected within six months of joining the scheme and involves paying higher contributions throughout membership.
It’s also possible to take out a separate pension scheme, such as an additional voluntary contribution (AVC) plan or a personal pension. These are ‘defined contribution’ schemes, so the amount of pension will depend on the growth of the underlying investments – they are not guaranteed or linked to salary.
While this doesn’t give the certainty of the main scheme, there are other benefits. Stan Russell, senior business development manager (pensions) at Prudential, explains: “You’ll be able to access this pension from age 55 and, as the pension freedoms apply, you’ll be able to take income whenever you like, even taking some or all of it as a lump sum.”
The official scheme is the Teachers’ AVC run by Prudential. This gives access to a wide range of funds, many with low charges. Mr Russell adds: “Teachers opting for our AVC will also have the benefit of having contributions taken at source, so they won’t need to worry about claiming back the tax relief.”
What are the options for early retirement?
Teachers can take early retirement from age 55, but pension benefits will be reduced actuarially according to age at retirement.
It’s also possible to take a phased retirement. Nilesh Shah, associate with actuarial firm Barnett Waddingham, explains: “A teacher can take up to 75% of their benefits before age 65, providing they reduce their pensionable earnings by 20% – effectively moving from five to four days a week – for at least a year.”
Are there any especially good or bad features?
On the positive side, the teachers’ pension scheme is unfunded, with the money coming out of government coffers rather than an investment fund. This is a rarity in the public sector and, by having the government as the backstop, offers members greater security than if it was dependent on investment returns.
However, Mr Shah says the exchange rate is very penal if you take pension as lump sum rather than income. Regardless of age, and subject to a maximum of 25% of the value of your pension benefits, you’ll receive £12 lump sum for every £1 of annual pension income that you trade in. Without factoring in inflation, they’re effectively saying they only expect them to have a life expectancy of 12 years. It may work out well for some but many retired teachers will live for much longer.
He also warns high earners to be mindful of the annual and lifetime pension allowances of £40,000 and £1 million, respectively. “Pension scheme membership entitles them to additional benefits such as death in service, so many teachers choose to pay the tax rather than leave the scheme,” he explains.
Have there been any changes recently?
Yes, the current scheme rules have only been in place since April 2015. Prior to that, it was a final salary scheme rather than being based on career average. “The new scheme is more weighted towards teachers with a flatter career,” says Tom McPhail, head of pensions research at Hargreaves Lansdown. “High-flyers who will see their salary increase over their career will lose out.”
Other key changes include the accrual rate, which improved from 1/60th to 1/57th, and the retirement age, which switched from 65 to the higher of 65 and state pension age. Contribution rates have also continued to nudge upwards, with the rate for a teacher earning £60,000 increasing from 8% in 2012/13 to 11.3% in 2016/17.
Transitional rules are in place for teachers who were members of the scheme before April 2012 and were within 13.5 years of retirement, with some able to stay in the final salary scheme. Otherwise, all teachers are now in the new scheme.
Are teachers happy with the changes?
Although this summer’s teachers’ strike focused on pay, Andrew Morris, head of pay and pensions at the National Union of Teachers, says members are still in dispute over pensions.
“Younger teachers who entered the pension scheme before 2007 have been hit the hardest due to the changes but, for many teachers, it does mean they’re working longer to get less in retirement,” he explains.
How does it compare to other schemes?
Seeing their benefits reduce is cause for concern, but the teachers’ pension scheme still stacks up favourably when compared to other workplace schemes. “It’s not as generous as it was and the member contribution rates are fairly chunky,” says Mr McPhail. “But it’s a guaranteed pension and I suspect a lot of people in the private sector would gladly trade.” Mr Shah says it also fares better than many of the public sector pensions, including the Universities Superannuation Scheme for academic staff in UK universities.
Where can I get advice?
Some independent financial advisers (IFAs) have set up separate arms to provide advice to teachers, for example Teachers Financial Planning (Teachersfp.co.uk) and Teachers IFA (Teachersifa.co.uk), but many IFAs will be able to provide pension advice. You can search for an IFA by postcode at www.moneywise.co.uk/find-an-ifa.