By USS’s own estimates, UUK’s DC proposal would reduce our future pensions to 40%-75% of our current DB promise
Our employers (UUK) have proposed the extension, to all salaries, of the defined contribution (DC) scheme that currently applies only to salaries above £55,550. Therefore, the pensions we would receive for our future years of employment would be based on nothing but investment returns on a pension pot into which the equivalent of 20% of our salary is deposited each year.
When DC above £55k was proposed in 2015, the Employers Pension Forum (EPF) released their notorious heat maps that were meant to show that many of us would actually do better under DC than defined benefit (DB). EPF were, however, able to construct such a rosy scenario only on the assumption that we would be able to purchase annuities at the cost of £23 per pound of pension income. This was far more generous than the assumed cost of an annuity in USS’s own consultation modeller. That cost, which was mandated by law to reflect market rates prevailing at the time, was c. £32 per pound of pension income.
In order to pre-empt any renewed attempt by our employers to make the case for DC on the basis of cherry-picked assumptions, I have applied USS’s own best estimates of returns on various types of assets over the next 30 years (see p. 19) to calculate how we would fare under UUK’s proposal. Employers cannot object to these estimates, since they are, in fact, more optimistic than the market-implied returns that many of them would prefer to use when it comes to the valuation of the DB portfolio.
Here is what I have found: If you will retire in 30 years, your expected DC pension will be worth about three-quarters (75%) of your current DB pension it would replace. If you will retire in 20 years, it will be worth about three-fifths (60%). If you will retire in 10 years, it will be worth about two-fifths (40%).
Your ‘expected DC pension’ is what you have at least a 50% chance of obtaining by eventual purchase of an annuity. What you end up with may be higher or lower, with equal probability, depending on actual returns on the investments in your DC pension pot and the annuity rates on offer when you retire. So the lower expected returns of a DC pension pot are accompanied by much greater uncertainty regarding the pension you will end up receiving, in comparison with the pension promise of our current DB arrangement.
Please click this link for a spreadsheet with my calculations and assumptions. As I explain there, my comparison is too generous to DC in the following respect: I assume a level salary throughout one’s career. But the longer one is invested in DC, the better it is in comparison with DB. Hence, for a typical early career salary less than £55,550, which later rises, DC will fare even worse in comparison with DB than my figures indicate.
[Click here to see how UUK could greatly improve their offer, at no cost to them.]