Final salary pension schemes offered to teachers across the UK are often lauded as ‘gold plated’, but scratch below the surface and you may find they don’t glitter quite as much as the label implies.
On the other hand, defined contribution schemes are often criticised for being less valuable compared to final salary schemes, but a well-designed defined contribution scheme can continue to provide a valued benefit to staff. Although member outcomes are less certain, they provide much greater flexibility around how and when members can access their retirement benefits, as well as flexibility with inheritance planning.
Sure the guarantees that come with final salary schemes can be attractive to staff, but those guarantees come at a cost: they assume the scheme is well funded and that ongoing funding levels, i.e. employer and employee contributions, are sustainable in the long term. It is estimated that TPS contributions could reach 30% in 2023. With total contribution costs increasing by 43% in 2019 (33% in Scotland) and further increases expected in future, sustainability is arguably the single biggest pension challenge facing independent schools today.
What about investment risk?
It is true that the investment risk under a defined contribution scheme sits with the scheme members and that the value of their investments, their pension pots, can go up or down. This is one of the main reasons why final salary schemes have been so valued historically, because the investment risk sits with the scheme first and foremost. However, a defined contribution scheme with a well-designed default investment strategy that has an appropriate level of risk versus return for your staff demographics and a de-risking glidepath in the run up to retirement, overlaid with good scheme governance to help keep everything on track, can effectively mitigate these risks.
In addition, unlike most final salary schemes, the majority of modern defined contribution schemes have adapted to Pension Freedoms, a legislative change in 2015 that allows members greater flexibility to choose when and how they take their retirement benefits in line with their personal circumstances rather than final salary scheme rules.
Defined contribution schemes are also much more portable than final salary schemes, usually giving members the option to take their pension pot with them when they change jobs and to shop around for the best deals when they decide to start taking their retirement income.
Consider all the costs
Some final salary schemes include additional benefits and there may be costs associated with ending your participation whether in full or part. These need to be identified and considered carefully before making any decisions.