A reader asks:
I joined the police two years ago and automatically enrolled in the police pension scheme.
I am paying 12.5% per month into my pension which seems like a very large amount compared to what you would normally pay into a company pension scheme.
I understand this is no longer a traditional final salary pension scheme where you would get a pension based on your final year salary; rather you earn a pension based on the salary paid each year - not nearly as good.
Should I carry on paying into this scheme or would I be better off paying the money instead into a personal pension plan?
The CARE 2015 Scheme
In 2015, the police pension scheme moved from a final salary scheme to a ‘career average revalued earnings’ (CARE) scheme.
For the last three decades, UK pension provision has been moved away from final salary and CARE schemes (Defined Benefit) towards money purchase schemes (Defined Contribution). In money purchase schemes, employer/ee contributions are invested tax-efficiently until retirement and then the final cash value amount is provided to the employee to fund retirement - there is no guaranteed level of benefit.
In the private sector, there are virtually no final salary or CARE schemes due to the high cost to employers, and the public sector is really the only place where a guaranteed final pension provision can be found. According to the CARE scheme literature, the employee may pay a rate of 12.44% of salary into the pension compared to between 3-5% for the average company pension scheme, but this is supported by an employer amount which is currently 21.3%.
The normal retirement age of the scheme is 60 with the option to retire at any time after minimum retirement age 55 with a reduced pension of roughly 5% for each year before 60. If you leave service before age 55, pension payment is deferred to State Pension age currently 67 or 68.
How is the pension calculated?
Under the CARE 2015 Scheme, pension accrues at a rate of 1/55.3 for each year of membership.
During the first year of membership, you accrue a block of pension which is 1/55.3 of your pensionable earnings in that scheme year.
At the start of the second year, the block of pension accrued in the first year will be increased by inflation measured by the Consumer Prices Index (CPI) plus 1.25% (CPI currently stands at 11.1%).
During that second year, you will accrue a second block of pension based on 1/55.3 of your pensionable earnings during that second scheme year.
At the end of the second year, the two blocks of pension will be added together and at the start of the third year, the combined amount will be subject to an increase of CPI plus 1.25%. During that third year, a further block of pension will be accrued, and so on.
This process continues throughout your period of active membership – no maximum number of years.
If you cease to be an active member of the CARE 2015 Scheme other than as a result of retirement, then the combined blocks of pension accrual will continue to be increased annually until retirement, but by the movement in CPI only.
So, for example, in the first year, an officer earning £21,000 would pay £2,612 (12.44%) into the scheme (which includes a tax-free bonus) and accrue a pension block worth £379.75 per annum (21,000 divided by 55.3).
If that officer remained an active member of the CARE 2015 Scheme for thirty years before retiring, and CPI remained at a constant 2%, then at retirement that one block of pension will have become an annual guaranteed pension worth £991.28 per annum (Compound interest in action). This pension will then be paid for the rest of life – increasing in line with CPI inflation.
CARE 2015 Scheme Benefits
The CARE 2015 scheme provides a guaranteed defined pension in retirement and an optional lump sum on retirement: you can give up part of your pension (up to one quarter) to get a lump sum when you retire. Every pound of pension that you give up will be paid as £12 lump sum.
The CARE 2015 scheme also provides special provisions if you are forced to retire through ill health. The Police Pension Authority has discretion to retire a member on medical grounds and there are two levels of ill-health pension which may become payable.
A lower tier payable if permanently medically unfit for ordinary duties but not permanently medically unfit for any regular employment - benefits based on the amount of accrued pension at the time of ill-health retirement with no enhancement or reduction for early payment.
An enhanced upper tier payable in addition to the lower tier if permanently medically unfit for ordinary duties and also permanently medically unfit for any regular employment.
The lower tier example: A 45 year old member has an accrued pension of £15,000 per year at the point of retirement on grounds of lower-tier ill health. The accrued pension of £15,000 will be payable immediately without reduction.
The enhanced upper tier ill-health pension is calculated as follows:
If aggregate period of service is less than 5 years, the annual rate of enhanced upper tier ill health pension will be the lesser of (a) or (b): More than 5 years’ service use (b).
The assumed period of pensionable service to Normal Pension Age (NPA) is currently 60 minus actual retirement date.
An enhanced upper tier example: a 25 year old member with 3 years service earns £23,000 per year and accrues pension of £1,200 per year retires on grounds of enhanced upper tier ill-health after being found to be permanently medically unfit for any regular employment. The enhanced upper tier pension will be the lesser of (a) 1,200 x 3 = £3,600 and (b) £23,000 x (60-25) divided by 55.3 × 2 = £7,278.
Total pension payable immediately is £4,800 per year (£1,200 + £3,600).
Example 2: a 35 year old member with 7 years service earns £35,000 per year and accrues pension of £5,000 per year retires on grounds of enhanced upper tier ill-health. The enhanced upper tier pension will be £35,000 x (60-35) divided by 55.3 × 2 = £7,911 per year.
Total pension payable is £12,911 per year (£5,000 + £7,911).
CARE 2015 Scheme dependents benefits
If you die as an active member of the scheme, i.e. still paying in, a lump sum death benefit is payable to dependents of three times final pay.
If you die whilst a member of the scheme, or in retirement, dependents will receive a pension for life. The pension payable generally is 50% of your pension at the date of death. The pension payable to an eligible child is generally 25% of your pension at the date of death, but if there are three or more children, then they will share half of your pension between them.
(Death or injury while on duty: If you die as a result of an injury, your dependent may also be entitled to benefits under the Police (Injury Benefit) Regulations. This does not form part of the pension scheme).
Paying Into a Defined Contribution Pension Instead
There is no doubt that a contribution rate of 12.5% into a pension scheme is significantly more than many people are contributing. However, opting out would lose the employer contribution which makes a significant difference to the value at retirement.
In the example shown earlier, an officer earning £21,000 would pay £2,612 and accrue a pension block worth £379.75 per annum. If that officer remained an active member of the CARE 2015 Scheme for thirty years before retiring, and CPI remained at a constant 2%, then at retirement that one block of pension will have become worth £991.28 per annum.
In comparison, paying £2,612 into a defined contribution pension (with no benefit of any employer contribution), increasing in line with 2% CPI per year for 30 years and a rate of return earned through investing of 5% per annum, this would generate a lump sum of around £21,000 which could be used to buy a lifetime annuity providing approx. £1100 per annum. This is not a guaranteed amount and does not provide a dependent pension nor any of the other benefits listed above.
Pretty clear-cut result if you were to opt out and move to a personal pension without the employer contribution. It would be fair to say that providing these salary-related, guaranteed pensions has become so expensive that most employers in the private sector have given up offering them, so they should not be given up lightly. The police pension scheme has a retirement age of 60 which is much lower than many other schemes and active membership also brings other benefits which would be lost if you opted out.
Should I opt out of the Police Pension Scheme?
When you are young, retirement can seem a long way off, so it can be tempting to choose to opt-out of the police pension scheme. However, if the State Pension was to be your only income in retirement this would mean quite a frugal existence, with greatly restricted lifestyle choices.
Defined Contribution or Money Purchase company pension schemes are a fantastic way for an individual to save and invest for their future retirement. As described in the post ‘ISA or Pension’, these savings plans provide invaluable tax benefits and free money to compound over the years and should not be missed.
But, despite the recent changes to the police pension scheme, it remains a very good scheme – one which could still be described as ‘generous’ when compared to a money purchase scheme. If you could opt out and take the employer contribution with you to a money purchase scheme, the option may be different – but you can’t.
In light of all this, here are ten reasons why opting out of the scheme is a step that should not be taken lightly:
1. Your employer will contribute almost twice as much as you do to the Scheme. This is essentially ‘free’ money that you will not get if you opt-out.
2. Tax relief on all your contributions.
3. No hidden fees or charges.
4. Life cover of three years pay and no medical requirements to qualify.
5. Once you are receiving your pension it will go up in line with inflation, protecting you from rising prices.
6. All members have the option to take a tax-free lump sum on retirement.
7. Guaranteed package of benefits with no investment risk.
8. Built-in protection in case you have to draw your benefits early through ill health.
9. Pension provision for loved ones if you die.
10. Ability to provide for your own retirement.