What Are Added Pensions (AP)?
For many public sector workers and I imagine private company pension schemes as well, there would be the option to ‘purchase added pension’. This basically allows you to buy extra pension benefits for when you retire. The younger you do this, the more you would get for your money because there is more time for your contributions to grow.
If you are on a defined benefit scheme (such as final salary or career average) then the benefit you get will not ‘grow’ because it is pre-determined (ignoring annual inflation revaluation). However, the younger you buy, the more defined benefit you will receive.
Pension schemes tend to be all unique in the way they operate, but they mostly have similar features to look out for:
- Is your pension a defined contribution or defined benefit scheme?
- How much do you need to contribute to be a member of the pension scheme (usually a minimum pound amount or a percentage of salary)?
- How often is your pension re-valued? Usually at the end of each financial year.
- How much will your pension be re-valued? Usually linked to some sort of inflation index such as RPI or CPI. This is to ensure that the value of your pension keeps up with inflation.
- What is the Normal Pension Age of the scheme (e.g. 60 years old)?
- What is the Minimum Pension Age of the Scheme (e.g. 55 years old)?
- If you were to retire earlier than the Normal Pension Age (e.g. between Minimum Pension Age, 55 and Normal Pension Age, 60), how much will your pension benefit be reduced by?
- How much will your pension increase by for each year you are a member?
- How much will your pension increase by once you retire?
- What benefits are there to your family if you were to die?
- If you were no longer in the scheme (e.g. leave the police or organisation), when can you access this pension, usually called Deferred Pension Benefits?
- Are there any lump sum benefits and how is this calculated (commutation)?
- Can you increase your pension (Purchase Added Pension)?
- What are the benefits and terms of Purchasing Added Pension?
My Police Pension
I wrote a bit about our work pension (mine and Mrs. CC) in Our FI Plan post, so I won’t duplicate it here again. However, the table below provides a short summary:
Member Standard Contribution Amount
12.44% to 13.78% of salary dependant on pay scale
Employer Contribution Amount
21.3% of annual salary
Normal Pension Age
Deferred Pension Age
State Pension Age – currently 68
Rate of Revaluation whilst Active Member
CPI + 1.25%
Rate of Revaluation once Retired
Annual Pension Benefit Increase
1/55.3th of pensionable earnings
As can be seen above, the Police pension is not as good as it used to be (we pay in more and get out less than before), however, it is still good compared to many private pensions and okay compared to some other public pension plans but not others (e.g. cough, politicians, cough).
Is Buying Added Pensions Expensive?
The minimum contributions above to be a member of the scheme may seem like a lot of money to some; and I agree, it really is. Mrs. CC’s friend recently joined the Police and he actually considered and was also persuaded by his mother not to join the Police pension scheme because it was a lot of money. Fortunately, his wife talked some sense into him.
Just because something is a lot of money, does not necessarily mean it is not valuable or worth it.
During one of our induction talks when I first joined the Police, I distinctly recall them mentioning the possibility of buying added pension. It was glossed over and the presenter said ‘it’s expensive so not worth considering’. Younger at the time and pensions being the last thing I wanted to think about, I just took his word for it.
As I continued on this journey towards FI and as my income began to increase slowly over the years, I decided to look into this as a way to build for a more secure future and also to save on tax (pension contributions are made before income tax, so it reduces your overall taxable income amount).
Here is what I found:
As can be seen above, by sacrificing 21.56% of my pensionable salary (annual payment of £9,300) for 6 years, it will buy me an extra pension of £5,571.90 (self only) or £4,896.49 (all beneficiaries – dependants will benefit as well) per year.
This makes the total approximate payment over the 6 years of £55,800.
The rate of return is 9.61% for self only (£5,571.90 / £55,800) or 8.78% for all beneficiaries (£4,896.49 / £55,800).
Here is another way to look at it.
How much would I need to invest privately (such as through an ISA or SIPP) to be able to safely withdraw £5,571.90 or £4,896.49 per year?
Using the controversial, but for simplicity sake, 4% safe withdrawal rate (read here and here), I would need to have invested £139,297.50 (£5,571.90 x 25) or £122,412.25 (£4,896.49 x 25) respectively.
If I were to be much more conservative and use a 3% withdrawal rate, I would need to invest £185,730 (£5,571.90 x 33.33) or £163,216.17 (£4,896.49 x 33.33) respectively.
Either way, I would need considerably more money invested to obtain a similar level of return that the added pension option would provide (saving up to over £100k by purchasing added pension instead of investing privately).
There is also the option to commute part of the pension into a lump sum tax-free payment:
You will be able to commute part (up to 25%) of your pension at a rate of 1:12; therefore for every £1 of pension given up you receive a lump sum of £12.
This means the £5,571.90 (self only) or £4,896.49 (all beneficiaries), could be commuted for a lump sum of £66,862.80 or £58,757.88 respectively in today’s money (assuming this is less than 25% of my total pension).
To me, I think this is a perfectly acceptable guaranteed return considering it will continue to increase in value every year by CPI + 1.25% whilst I am a member and increase by CPI once I retire or leave the scheme. It will provide a lifetime of income without worrying about ‘safe withdrawal rates’. My wife and children will also continue to benefit (albeit at a reduced amount) once I die.
By paying in an extra 21.56% of my salary on top of the minimum 13.44% to be a member, I am sacrificing a total 35% of my salary. This probably explains why when I spoke to my payroll, the lady on the phone was surprised and double checked the numbers with me.
I get it, it is a hell of a lot of money to sacrifice for a benefit which I may not even receive if I die early. However, see my post: Living Optimistically Through FI for my thoughts on such a mindset. We honestly don’t see it as a sacrifice and are very content with our standard of living.
When I told Mrs. CC about the benefits of buying added pension, we started to look at her military pension which is similar to mine. However, the major difference is that she gets all the benefit without the need to contribute a penny. This is part of the compensation for accepting the risk of deployment anywhere in the world and as a family having to relocate every few years as she moves to a new unit. Turns out her pension has the option of buying extra benefits too:
As can be seen above, a £2,400 annual contribution towards Mrs. CC military pension buys her £224.72 of additional pension per year once she retires (likely to be state pension age as she will leave the service early). This is a return of 9.36% (£224.72 / £2,400). Her pension is similarly uprated each year to keep up with inflation.
We have decided to buy less added pension for Mrs. CC because we can’t afford to buy more whilst we concentrate on paying off our mortgages. We will look to increase the amount we buy for Mrs. CC next year depending on our numbers and how much tax we need to save.
On the note of mortgages, we have just made an additional lump sum payment towards Mortgage 1 which has brought the debt down to less than £50,000. Our new pay off date has reduced by three months to June 2020. We hope to pay additional lump sums every so often and eliminate this first mortgage by April 2020.
How Does Added Pensions Fit into Our FI Plan?
As a family, our aim is to spend less time working and more time together. This means that despite the option being there for me or Mrs. CC to remain in the Police or Military even once we reach FI, the reality is neither organisations in its current state or in the foreseeable future is able to offer us a flexible enough working arrangement which would allow us to pursue our passions, such as long-term travel and charity work. As a result, we would both end up leaving the pension scheme early and automatically becoming deferred members.
Our contributions to-date would be protected and still continue to increase to keep with inflation. However, the pensions will not be payable until we reach state pension age – currently 68. This means we need to plug the 30-year gap from when we intend to stop working (perhaps late 30s) to when the pension is payable by relying on our rental income.
Our back up would be our ISA and Savings Plans. The backup of our backup plan is to sale one of our properties. There is of course always the option for us to return to work even if it is only one of us on a part-time basis. Mrs. CC has indicated she would always want to be a Nurse so intend to work a few shifts a month even once we are FI. Whether this is realistic or practical with our plans for travel remains to be seen.
Boring Stuff Right?
I’m a bit sad. I love this stuff. I think our pension administrators get more calls and emails from me asking for clarification on certain points than they would like or ever expect from a copper. I know this stuff is dry and downright boring for most. Mrs. CC has no interest in it. She just wants the headlines from me so we can make a decision together. She leaves the finer details to me. It works well for us like this.
The days of so-called ‘Gold Plated’ final salary pensions are over.
Public service workers and those lucky enough to have defined benefit schemes in the private sector need to have a complete mindset shift. We must assume that the government or company will forever try to erode our pension benefits to save public money or to please their shareholders. We cannot blindly put our faith in those who pay our salary. Our interests are not aligned and our current pension scheme will not remain the way it is in the future.
For example, when the police pension scheme changed in 2015, I know of many officers who were not close enough to their retirement age to be protected from the changes finding out that they had to work many years longer. They were close to retirement, but just not close enough. Their whole retirement plans changed just like that. Any dreams of chilling out, travel with the family or whatever were placed on hold and now replaced with years more of work.
That sucked, but there was absolutely nothing they could do about it.
A few years down the line from now, when the government decides to make more changes, the goal post will be shifted once again. People are living longer. The government has less money (or is wasteful with it – I can’t decide which one, but it’s probably both). When it comes to pensions, expect that changes will continue to occur and not in a good way. If in the unlikely event it doesn’t happen, then it’s a bonus. Only once we accept this can we start thinking of ways to increase our savings rate and develop other income streams to allow us to retire comfortably earlier.
So is exercising our option to buy added pensions in of Police and Military pensions worth it? For us, the answer is a definite yes!
I hope this post helps to explain what added pensions are and how it can help boost your retirement funds. I believe they are worth it depending on the age you buy them. The older you get, the less benefit you are able to buy for every £ you spend. So get a quote and see for yourself if it is worth it. You never know, the future you might be very grateful for it.
What do you think? Would the above numbers make the purchase of additional pensions worth it to you?
Humans of FI