How to use the pensions calculator

I’ve had a good play with the new updated pensions calculator, and it has been exceptionally illuminating.

The first thing to say is that almost everyone will need to make changes to the default figures to make a meaningful prediction. The defaults drastically overestimate the benefits of CAB2011, leading to a wildly inaccurate comparison of future future benefits under the different options.

And it is actually relatively easy to work out what figures you should enter to make your own predictions, and therefore make a reasonable comparison between the three offers.

But if you don’t want to read any further then I suggest you make the following changes to the default figures. Enter 4.5% for inflation, and add 2.5% to that figure for each promotion you expect to get before you retire. For investment returns put 6.0%, and increase your rate of contributions to the DC plan to 8% (the max permissible).

But if you want more detail, read on. (I suggest you have your pensions calculator open as you do this.)

Just to recap, the BBC offers are:

1) Stay in the final salary scheme, but accept that your pensionable salary will rise by only 1% a year max

2) A new defined contribution (DC) scheme, where you and the BBC pay into a stock market based fund (you choose how much) which (hopefully) rises in value, and when you retire the pot of money is used to buy an annuity (or annual income)

3) The new CAB 2011 which is based on 6% contributions from employees, and a pension that is calculated on the average of your salary

The first thing to say is that the crucial sensitivity is the difference between the figure you enter for the future increase in inflation (A2), and the figure you enter for your future increase in salary (A3).

Let’s concentrate on salary for a moment.

Most people filling this column (A3) will think of their annual pay rise, which at the moment is low, or non existent, and they’ll think that the default option (2.5%) sounds reasonable. Don’t be fooled. Stick with this figure and you’ll drastically underestimate your future salary. Unless you’re in the last few years of your career, then you can reasonably expect promotion at some point before you retire. If you’re younger than me, you can expect more than one promotion. Each promotion should involve a salary jump. And intuitively we know this is true: most of us expect to end our careers further up the pay scale than we began them. So for the vast majority of people, whatever figure you enter in column A3 should be higher than the figure you enter for inflation (A2).

OK, can we be a bit more specific about how much higher your salary rise should be than the inflation figure? Yes we can.  Ask yourself this question: in today’s money, what do you expect to be earning when you retire? You can then use this link to work out the average increase in your salary through to retirement. (You enter your existing salary, your expected salary on retirement, and the number of years until retirement. The calculator spits out a percentage figure – called the discount rate. It’s in dollars, but just ignore that.) Now, back to the pensions calculator. Whatever figure you enter for inflation, add on your discount rate to get the figure you should enter in box A3 in the pensions calculator. This is the average annual increase in salary that you can expect up to your retirement.

Right, let’s deal with inflation. RPI inflation is the broadest measure of inflation, and generally assumed to be the most realistic reflection of real living costs. Currently it is 4.7%, and over the last 30 years it has averaged about 4.5%, so that’s a good starting point for box A2. But the beauty of the pensions calculator is it is relatively insensitive to this figure: the key factor is the difference between inflation and your salary. So if you think that the government can stick to its 2% inflation target (measured by CPI which is usually lower than RPI anyway) then put 2% in. But whatever figure you put in for inflation, make sure that you add your discount rate on top for the salary figure (A3).

OK, that leaves future investment returns (which are only relevant for option 2). Again, hard to predict. Over the last few years they’ve slighly beaten inflation, so again, the key thing is to make this figure bigger than your inflation figure. But not by too much: over the long term the stock market only beats inflation by a relatively small amount, and in any case a pensions fund won’t all be in the stock market, it’ll have some lower yielding (but safer) components as well. I’d suggesting adding 1.5% to your inflation figure. Once you play around with the figures it quickly becomes apparent that the only circumstances in which the DC scheme makes sense is if stock market returns massively outperform inflation for a sustained period. I think that’s unlikely.

So, that’s how to use the pensions calculator. What happens when you follow these guidelines?

The broad conclusions are clear. If you stick with the default figures then CAB2011 can in some cases look good. But that’s because the assumptions for the vast majority of people will be hopelessly inaccurate. I’m a well paid Executive Producer, and if I put the default figures in, then CAB2011 pays about the same as the existing final salary scheme. But if I assume one more decent promotion before I retire (inflation 4.5%, salary increase 7.5%) then under CAB 2011 I am £20000 (yes, twenty thousand) a year worse off than on the existing scheme. The other alternatives are even worse.

It’s not that surprising. CAB2011 is a con, designed to confuse the issue, which is the destruction of the BBC’s existing scheme for nakedly political reasons. If we weren’t massively worse off under CAB2011 then Mark Thompson wouldn’t be able to boast about saving money, and the whole exercise would be pointless.

I’d be really interested to hear other people’s experiences of using the pension calculator.

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One Response to “How to use the pensions calculator”

  1. The consultative ballot « Jonathan Renouf's BBC Pension Blog Says:

    […] back at the start of the summer, we’d have thrown it out. Anyone who has played with the pensions calculator following the principles I laid out a week ago will know just how bad CAB2011 […]

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