You have a final salary pension scheme and you’re approaching normal retirement age. Should you just take the money and enjoy it as soon as you can? But that’s just what your employer wants you to do, says Matt Harris of Dalbeath Financial Planning.
Meet Stuart. Based on a real-life client of Dalbeath Financial Planning, Stuart is a mid-level manager at a major high street bank. At the age of 55, he isn’t particularly keen to work for his current employer for many more years. But ‘luckily’ for him, the bank is encouraging him to take early retirement.
Why? Because they would like him to. We find this happens disturbingly often – big companies that offer final salary pension schemes, as well as government employers such as local councils, are always a little too keen to help their staff retire early. Could this be due to the cost of keeping older staff members in expensive final salary pension schemes? Rather than being, for instance, in the best interest of the employees themselves?
We find that bank employees, teachers, and council staff are particularly vulnerable to this. At each annual salary and benefits review, and throughout the year, staff are nudged towards the option of taking early retirement. Understandably, many grab this opportunity with both hands, and the subsequent peer pressure creates a situation where early retirement is seen as the norm. However, our research suggests that few staff members fully understand the financial implications of their choice.
Let’s do the sums
Stuart is a prime example. Many of his colleagues took their final salary pensions between the ages of 55 and 60, but Stuart decided to ask for independent advice before taking the leap. He was a bit shocked, to say the least. We asked him to request pension projections from his employer, and we laid them out in easy-to-understand charts and tables. This is what they showed: If Stuart retired at 55 he would receive a pension of £23,763 per year, or a reduced pension with a lump sum of £111,000. If he waited till he was 60 his pension would be £34,276 per year, or a reduced pension with a lump sum of £158,000. Finally, if he held on till 65 he would receive £49,297 per year, or a reduced pension with a lump sum of £224,000.
The differences, as you will agree, are staggering. Such are the penalties for retiring at 55. For each year of Stuart’s early retirement, he sacrifices approximately £2,500 of annual pension income – and that’s guaranteed annual income for life. If he chose the lump sum route, then for every year of early retirement he cuts his tax free cash payment by £11,000, as well as his income.
But ah, you might say – if Stuart retires at 55 he’ll be receiving his pension income for longer than if he retires later. So doesn’t it balance out in the end? No, it doesn’t. Our projections showed that if Stuart retires at 65 then, by the time he is 85, he will have received £250,000 more in cumulative pension income than if he retires at 55. How many employees understand that the cost of early retirement could be in the region of a quarter of a million pounds?
The cost of not taking advice
The fact that such employers make it so easy to take your pension early, without any requirement to take advice, can lead to farcical situations. One of Stuart’s colleagues opted to start taking his pension at 55 but continue working with the company full time. As such, he is suffering the double whammy of large early retirement penalties on top of paying higher rate tax on a big chunk of his income. (And of course, he still has to go into work!).
With the benefit of advice, Stuart decided that the best route would be to look for another role within his company that he would enjoy more, even if it meant taking a salary cut, to enable him to defer accessing his final salary pension scheme. He even has the option of leaving the bank and doing something completely different, but not taking his pension until later. Both of these options allow him to avoid those damaging early-retirement penalties, and will leave him with a much greater income in retirement. But he does have one big issue still to think about: how he is going to spend all that extra money. Which is a very nice problem to have.