What is a Defined Contribution (DC) scheme - and should I be concerned that it is not as good as a Defined Benefit (DB) scheme like the Teachers’ Pension Scheme (TPS)?
A DC scheme is a type of pension where contributions from the employer and employee are paid into a fund, which is invested and then converted into a pension on retirement, normally in the form of an annuity.
In the vast majority of cases, DC schemes do not perform as well as DB schemes and, if you are moving from a DB scheme to a DC scheme, you are likely to be worse off even if your employer gives you an incentive to leave your DB scheme. Under all reasonable assumptions, a DC pension cannot provide anywhere near equivalent retirement benefits to the TPS, for example.
Why do defined contribution (DC) schemes generally provider inferior pension benefits to defined benefit schemes?
The main reasons why DC schemes perform worse than DB schemes like the TPS are poor investment returns, high or hidden scheme management charges that eat away at the DC fund, and poor and falling annuity rates. Another reason is that employer contributions tend to be much lower in DC schemes.
Are there any other potential disadvantages in DC schemes compared to DB schemes?
DB schemes like the TPS and LGPS have a range of benefits apart from an annual pension that a DC scheme may not provide. These include death in service benefits, an ill health retirement pension, index linking of pension, opportunity to retire early on reduced benefits, benefits for partners, and a tax-free lump sum option. DC schemes may not provide all or any of these benefits. The NEU would argue that if your employer chooses to have a DC scheme, you should not lose out and your employer should provide these benefits through related insurance cover that is comparable to what you would have received in a DB scheme.
My employer contribution rate to its DC scheme is lower than what employers typically pay into a DB scheme like the TPS - should I be concerned?
The main justification given by employers for having a DC scheme, rather than a DB scheme, is affordability and the possibility of increased costs of DB schemes where contributions are not fixed but depend upon scheme valuations.
Moving to DC has often been used by employers as an excuse to cut their contributions at the same time. This should not be a race to the bottom. Employers should ensure that they pay as much as reasonably possible into DC pension schemes, so that benefits at retirement are as good as they can be.
Most NEU members are either in the TPS or Local Government Pension Scheme (LGPS), both of which are public sector DB schemes. The average employer contribution rate in the public sector is 20% and the average employee contribution rate is 8.5%. In order to have any chance of replicating the level of benefits one can expect to receive on retirement in a DB scheme, the NEU recommends that both the employer and employee contribution rate in a DC scheme is as high as possible.
Why is it important for my employer to pay as much as possible into my DC scheme?
Unlike the TPS or LGPS - DB schemes where the level of benefits at retirement are guaranteed based on salary and service - DC schemes guarantee only how much will be contributed, not the level of pension. In a DC scheme, the retirement benefits for each member depend on how much money has been built up by the member's retirement date and how well the investment has performed. Therefore, the higher the employer and employee contribution rate in a DC scheme, the better level of pension at retirement.
My employer is offering staff who join the DC scheme higher pay - will this make up for not being in a DB scheme?
Any potential advantages of taking a higher salary and moving to a DC scheme will be short term. Once you weigh up the higher salary against the loss of pension at retirement, you will find that in the vast majority of likely scenarios, you are financially worse off.
In a DC scheme, your future pension income cannot be predicted with any certainty. However, using reasonable assumptions, the NEU believes that higher salaries cannot compensation for the loss of pension at retirement. Please see our Technical Note that accompanies this FAQ.
My employer is proposing to replace our current TPS membership with a DC scheme. What can I do?
By responding collectively, as members of the NEU, you can influence the outcome. If there is a proposed change to pension provision, the employer must undertake meaningful consultation of staff. Further, for many employees, their right to TPS membership is contractual. This means that it cannot be simply taken away.
Many NEU members working in the independent sector have faced this threat. Members in over 50 independent schools have successfully resisted employer proposals to leave the TPS. Others have forced improvements to the alternative package. Unfortunately, some have lost the TPS. The necessary leverage to force concession, in most instances, has been willingness to strike action. For further information, see the NEU campaign page: Protecting independent school teachers' pensions
Should I consider pension as part of my overall remuneration and negotiating on pay?
Yes, pension is a fundamental and significant part of remuneration and, perhaps, nowhere more so than in education with the TPS or LGPS.
If your employer does not provide access to the TPS or LGPS then, in benchmarking against jobs where it is, this gives cause to the argument that pay should be higher. If your employer is proposing to leave the TPS and all avenues to resist the change have been exhausted, members could consider negotiating improvements to pay, or other areas such as sick leave or family friendly rights.
Some NEU members and employers have, as a sweetener, agreed improvements to pay bands and higher than would be expected cost of living increases. For instance, a pay increase of 3%, when it might otherwise have been 1%. But, as noted above, this will generally not compensate for the eventual pension shortfall.
What areas should we look at negotiating if members are unable to, or do not wish to, take collective action to prevent the loss of the TPS?
The key area to look out for is the level of employer and employee contributions paid into the scheme. The higher the employer and employee contribution rate, the more likely a better level of benefits at retirement - see questions 4 and 5 above.
Most employers argue that they cannot afford to sustain the increase in employer contribution from 16.4% to 23.6%. It is logical that their employer contribution to any alternative DC pension scheme should still be at least 16.4%.
The TPS employer contribution increased in September 2019 and employers who simply could not afford it left then. Continuing in the scheme after that suggests that there is money in the budget.
What else can I do to maximise my pension at retirement if my employer decides to implement a DC scheme?
Members of a DC scheme will have little control over how a fund performs or investment returns. However, it is good practice to:
- Shop around to give yourself the widest choice and take your time to get as much information as you can before you decide.
- Compare products from different providers.
- Check what charges you will you have to pay and when.
The NEU is not permitted to give financial advice and suggests that members seek independent financial advice at this point. We recommend that you contact Lighthouse Financial Advice for personal independent financial advice. NEU members can receive a free, no obligation initial consultation, either 1-2-1 or school meeting. You can book your complimentary, no obligation initial consultation by calling 0800 085 85 90 or visit lighthouse.
What happens at retirement if I have TPS benefits and benefits in a DC scheme?
Your TPS benefits are fully protected and will be paid to you as normal when you retire. Your benefits will have increased in line with inflation from the date you left the scheme.
You will be responsible for deciding the method by which you claim your DC scheme benefits at retirement. There are several options. You can buy an annuity, which is a product designed to give you a guaranteed income for the rest of your life; or enter into income drawdown which sees you leaving your money invested in the stock market and drawing an income from it; or you can also take the pot in one go (subject to taxation) or in chunks. How much income you get will depend on how much has been saved in your pension pot through combined employer and employee contributions and how well your investments have performed.
Again, the NEU is not permitted to give financial advice and suggests members seek independent financial advice at this point. We recommend that you contact Lighthouse Financial Advice for personal independent financial advice – see above.
Can I transfer my TPS or LGPS benefits into a new DC scheme?
No. Both are public sector pension schemes and current legislation does not permit transfers from unfunded public sector schemes to DC schemes.
If your employer decides to leave the TPS or LGPS, your benefits accrued to date will be protected, will continue to be index-linked, in line with the annual pensions increase (currently CPI inflation) and you will become a deferred member. You can claim your TPS or LGPS pension benefits at your normal retirement age, or earlier if you take an actuarial reduction.
I am worried about how all of this will affect my retirement plans - what can I do to find out more about other investment options?
We recommend that you contact Lighthouse Financial Advice for personal independent financial advice.
What can I expect from a financial adviser?
The adviser will discuss your personal circumstances and financial position with you. They should also be able to:
- Check the difference between the TPS and proposed new scheme
- Compare the benefits you might build up in the TPS against the proposed new scheme
- If there are different options available, advise which one is best suited to you
- Assess your current level of pension benefits against your retirement plans and advise accordingly
- Give you a summary of the advantages and disadvantages of your employer’s recommendation
- Ask whether you have discussed your decision with your spouse or civil partner, as it probably affects them too
- Check your full range of options