This chart is from LCP’s excellent paper “the ski-slope of doom” which explains that a generation of workplace savers employed in the private sector will no longer be getting DB pensions but inferior DC pots (which they will have to turn to pensions).
For them the getting through retirement looks like a black run!
While those in peril are in the orange and red slices of the pie at the top, those on the blue and green runs are in the grey slice. They are the 6.6m people paid by the public purse to teach, police, fight fires and judge; they work in local government, in the NHS or in the civil service.
And those with public sector and state pensions could do even better by using available facilities to top up these pensions
I found myself this week talking to people who are in public sector pension funds , I was amazed at the deals available to them. So I thought the perspective of someone who most definitively isn’t a public servant might be useful.
I urge you to use available cash you have to improve your retirement prospects by topping up your public sector pension and perhaps your state pension too!
Financial advice (and tax)
On this occasion, I’m not suggesting you automatically go to an IFA for advice. What I’m suggesting costs you nothing in fees as you can get these deals directly through Government and private websites.
If you are a high earner or if you’re like Jeff and been in a public sector scheme all your life, you should model before you meddle. Most public sector schemes offer modellers to check if you have headroom to improve your pensions and there is a lot of guidance to be had from the schemes and from unions. Here for instance is the guidance to members of the NHS pension scheme from the BMA.
The three limits you should be checking if you have pension wealth and/or are a high earner in a publics sector scheme are 1) the lifetime allowance (LTA), 2) the Annual Allowance (AA) and if you are or are thinking of drawing down from a personal pension of SIPP, the Money Purchase Annual Allowance (MPAA).
I worry that some advisers over-egg these three tax problems.
Much financial advice to high earners on pension top-ups is “don’t risk it – take out an ISA” – with the “it” being the risk of breaching the AA, MPAA or LTA. This advice carries its own risks, principally the risk of missing out (opportunity cost).
I’d remind the expert reader that pension tax limits are largely irrelevant to most people. To quote Steve Webb at a recent PMI event
“According to HMRC, “95% of savers approaching retirement are currently unaffected” by the LTA
With regards Annual Allowance charges, in 2018/19:
-13,660 charges reported via ‘accounting for tax’ returns by schemes
-34,220 people reported contributions over AA via self-assessment
In that year there were 31,600,000 taxpayers!
Most people don’t earn £40k per year, still less put that much in a pension!
One limit which does matter to ordinary people is MPAA which needs reform”
MPAA – an unexploded bomb
Sadly, the MPAA is rarely mentioned in any Public Sector documents , it is a limit that occurs where someone starts drawing money from any pension while still saving into other pensions.
Drawing from a personal pension while saving into a public sector reduces your annual allowance to the money purchase annual allowance level of £4,000 pa. This presents a much more significant risk to many in public sector pensions, a risk that can be easily avoided by leaving pension pots alone – until you’ve started taking your public sector pension.
Further information and guidance available on pension tax.
Be aware that paying Class 3 NICS (see below) does not impact your annual or lifetime allowance. It is usually a better way to top up a pension than to use an ISA if you have annual allowance problems – I hope that IFAs point this out.
In any case, if you are lost – you can also get personal guidance from Money Helper. This guidance will be based on the provision of factual information and will be, I hope, aligned to what you are reading here.
Most people who have problems with the Annual and Lifetime Allowances know to speak to IFAs and accountants.
If you are considering topping up or drawing on any pension and are not clear after reading this article, please validate your decision with an independent financial adviser. Be aware, this could and should cost you a fee.
Part One – Topping up your Public Sector Pension Scheme
Firstly. public sector pension schemes do not always provide you with a full pension. Infact unless you are in a public sector scheme a full 40 years (hat-tip to LGPS supremo Jeff Houston who has ) you will need to pay extra pension contributions to properly replace your wage in retirement. You can do this in two ways.
1.1. Paying for extra service (added years)
In the olden days, people bought added years of service, but this has rather fallen out of favour as the terms for purchase aren’t favorable to members. Instead there has been an explosion of interest in another way to top up your public sector pension. You can read more about this option here (this is the LGPS example- you can do this in other public sector schemes).
1.2. Paying (money purchase) AVCs
This other way is known as paying AVCs and there are a number of insurance companies who provide investment services to public sector funds. Prudential are the main one, followed by Standard Life, Clerical Medical and General, Scottish Widows, Aegon , Zurich and L&G. There are still a few AVC schemes with the now discredited Equitable Life (who now trade as Utmost).
The great thing about these AVC schemes is that they can be exchanged at retirement for tax-free cash, meaning that on your AVCs you get tax relief on your contributions, your investment and on your cash benefit. It also means you don’t have to sacrifice pension to take your cash (often on unfavourable terms).
Although you still have a choice, the vast majority of those who choose to top up, use AVCs over added years.
1.3 Paying Shared Cost AVCs
Recently, a new kind of AVC has been pioneered for the Local Government Pension Scheme called a “Shared cost AVC”, where the cost of contributing is even lower as the employer shares savings in national insurance by paying your contributions for you (in exchange for salary).
You pay £1 per month into your AVC fund as your contribution and the remainder of your total monthly contribution amount is paid by your employer, through a salary sacrifice arrangement.
You make savings in Income Tax and National Insurance Contributions (NICs) on the amount of pay you have sacrificed. As a result your take home pay increases in a Shared Cost AVC arrangement, when compared to paying AVCs in the standard way.
The organisation that has made this AVC sharing possible, AVC Wise has so far only marketed it to the Local Government Scheme, but the standard AVCs are available to any member of a public sector plan.
If you are an LGPS employer and you are not using Shared Cost AVCs, you can contact AVC Wise on this link
If you are in the LGPS and your employer offers Shared Cost AVCs you should contact AVC Wise on this link.
If you are in the LCPS and your employer doesn’t offer Shared Cost AVCs – you should contact AVC Wise on this link and they’ll see what they can do
You can learn more about the LGPS and Shared Cost AVCs by watching this video
Part 2 – Topping up your state pension
Public sector pension schemes were designed to provide a part of the old state pension with a part of member and employer’s contributions. In return for this, both paid lower national insurance contributions. The problem today is that for the time that people paid lower contributions, they were not building up an entitlement to the state pension and some people retiring early from Government schemes may not have a full 35 years contribution history. That means they’ll get a reduced state pension.
This Government video explains the basics well
2. Paying Class 3 National Insurance Contributions
If people have decided to opt out of work, they may not be able to make up these “lost years” and get to their full set of 35. Instead they can buy the years back paying what are called class 3 National Insurance contributions.
Buying extra state pension is becoming an increasingly popular use of pre-retirement cash – especially as payments aren’t part of your annual allowance (if you are struggling with that – lucky you!)
The reason why Class 3 NICs have been growing in popularity is that they are a very cost-effective way of buying extra state pension.
The cost of buying an added year in 2021/22 is £15pw or £800 pa. Each additional qualifying year works out to be an extra £5.13 a week (or £266.83 a year) in State Pension, based on 2021/22 rates.
So you only have to live 3 years past your state pension age to find yourself in credit. Compare this to an annuity purchased from an insurance company and you will see what a bargain class 3 NICs are for those who need them and can pay them.
Of course before you think about Class 3 NICs you should check to make sure that you aren’t going to get a full state pension anyway or that the extra years are needed. You can only go back 6 years to purchase extra state pension , so the benefit is rationed but if you have headroom and can afford it, this is a sensible investment of cash in the bank for people close to retirement to consider.
I’m grateful to Aon’s Lydia Whitney who points out that
you can always go back 6 years to fill in gaps but some people can also fill in earlier gaps. It is a complex set of rules so do check your forecast. This loophole to go back more than 6 years closes in April 2023 so do check whether you could take advantage if you are not going to get to 35 years by the time you retire. It can even cost you less than £800 if you had some earnings that year but not enough.
You can find out how do this by using this Government website using these contact points
Which should I do first?
In my opinion, the advantages of AVCs and especially Shared Cost AVCs are so great that you should look at them first. Of course you may have no headroom to bolster your benefits (like lucky Jeff Houston) but most people can and the only downside of paying AVCs is if you are so well off that you fall foul of Annual Allowance or the Money Purchase Annual Allowance (details here). You may already be protecting your Lifetime Allowance in which case AVCs are definitely a “no-no”, but these are first world pension problems and if you are rich enough to have them, you should have a financial adviser or accountant to help you!
For those who have topped up their state pension or have an anathema to investing money with an insurance company, paying added Class 3 NICs is an obvious alternative.
Model before you meddle!
But only think of investing for your future once you’ve worked out what your income in retirement is going to be. You can do this using a modeller provided by your public sector scheme or by referring to your most recent pension statement (this link’s for the Civil Service Scheme but all public service schemes should offer one) . Once you’ve worked out your works pension , check out your state pension using this link.
When you have the information from your public sector pension, your state pension , you can add in any other pension pots or pensions you have found and use the Moneyhelper calculator to work out how far short you are of where you want to be .
Although public sector pensions are brilliant, most people will not get a replacement salary from them in retirement (even with the state pension included) is less than £5,000 p.a. That’s because people don’t stay long enough in the scheme and sometimes miss valuable years of pensionable service.
Put together, the State Pension and your public sector pension , put you ahead of the game. Ram home your advantage by investigating these two great ways to boost your income.