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
60
Minimum Pension
55
Deferred Pension Age
State Pension Age – currently 68
Rate of Revaluation whilst Active Member
CPI + 1.25%
Rate of Revaluation once Retired
CPI
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 9.99% 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?
Further Reading:
Police Mutual Regular Savings Plan: The First One Matures
Humans of FI
Subscribe to Blog
Read more…
I think if added pensions had been offered at the last place I worked, I would have taken them up but not when it counted, ie when I was younger because that was when I was in debt and it was enough that I was just paying into the pension (DB)!
Since I won’t be able to get my hands on the pension until I’m 65, there is a risk that something could happen in the meantime, that might delay or reduce my payout. But I can’t worry about what might or might not happen so it remains a huge part of my plan (in the later years) and I’ll deal with the fallout when the time comes.
Yeah, the fact that my pension will become deferred to state pension age is a bummer. I am expecting the state pension age to be around 75 for me in all honesty, possibly even higher. However, at least it’s a nice safety net and an extra bit of income for our later years like you say.
I love this post, thank you so much for writing it!
Real value & slot for me to think about.
Glad it helped Tory. Like most thing FI related, I wish I was taught this at training school.
I’m also in the 2015 CARE scheme and have been considering contributing extra per month to reap the benefits when I retire. This post has confirmed my decision for me. I only wished I had thought long term 10 years ago when i first joined the job. Oh well. Thank you for this very informative post.
Hi Sharan. Thanks for stopping by. If you think of anyone else who might benefit from the post, please share with them. Like you, I wish I started much earlier had it been explained to me properly.
Thank you for writing this blog – the last bit about how your understanding of the future frames your decisions particularly useful. I’ve recently joined a scheme with an added pension option, and I’m trying to understand the logic of when it makes sense to pay in -i.e. assuming that you want to get near to the ceiling AP (£6500 in your example) if makes more sense to pay lots into added pension now (when younger and hence the rate of return is better) or pay down mortgage first. Do you have a sense of whether it is substantially better value to buy AP when younger? I.e. does the attractiveness decline steeply with age? (I assume so, but not sure what drives this…) Thanks in advance!
Hi Giles. Thank you for your comments. You pose good questions. I intend to write a new post on added pensions because the Autumn 2018 budget made some changes which come into effect April 2019. The changes will reduce the rate of return for some on new added pension contracts.
In relation to your query, I am not a pension expert. However, you are indeed correct that as you get older, you will get less value. It all depends on the Government Actuaries Department who update the factors used to determine the cost of AP (Added Pension) contracts and ultimately how much we get in return.
If you think of it this way. The money you pay for the AP contracts is not simply held in a cash bank account and given back to you as a pension when you retire. The money is grouped together with everyone else’s money and invested. Like all investments, the more time there is, the greater the effect for compound interest. As a result, age is one of the key factors used to calculate how much future pension you will get in return for your money now. The closer you are to the pension scheme retirement age, the less the return. I hope that makes sense.
In terms of paying down your mortgage vs paying for added pension. That’s a question of math and personal preference. That needs a whole post in itself (I’ll add it to the list of things to write about). I would start with calculating the ROI on the added pension you’re considering (get a quote – be careful, some schemes only allow one quote per year for free). Once you have this, work out how much money in interest you’ll save if you were to consistently overpay your mortgage by a realistic amount. The important words here are consistent and realistic. If you use unrealistic numbers, then the result will cause a bias in your decision making and skew you towards overpaying your mortgage. These two numbers won’t be the key determining factors, but it is a start.
I hope that helps for now.
Hi. Fellow cop here. 16 years in and (promoted) this year to insp. been going for FI for a while now and have been using ISAs Lisa’s and SIPPS. My aim is to go at 55 on a reduced pension so have been bulking up the rest of my passive income to compensate.
I am so annoyed I never knew this was a thing!! (Why aren’t the fed telling us about this!). I could have started AP a few years ago.
Any views on AP compared to a LISA?
Hi Jon! It always nice to read a comment and it’s especially so when it’s from a fellow blue. Congratulations on the promotion!
AP vs LISA? I’m not sure the answer is as straight forward.
The first point to consider is: when do you want (or need) access to your money?
With AP, assuming you’ll be FI at 55 (great job btw) and decide to leave, your Police pension will be reduced. If you leave earlier than 55, then it will be deferred to state pension age – currently 65, moving up to 68 and beyond. Whereas with a LISA, you can only access it at 60. [note: corrected from earlier comment]
The second point to consider is: are you a higher rate (40%) or additional rate (45%) tax payer?
With LISA, you get 25% bonus (maximum £1,000 bonus per year) but an AP gives you a more generous tax relief to reduce your income tax now especially if you’re a higher rate tax payer.
The third point is: pay tax now or pay it later?
With a LISA, you are using your after tax income to invest. When you withdraw, it will be tax free. With an AP, due to the tax relief, you are effectively using before tax income so you may be taxed at the time of withdrawal (depends on your tax rate at the time). So if you’re a higher rate payer now and expect to be basic at point of withdrawal, then AP might get the edge on this point.
The forth point is: how much can you invest?
With a LISA you can only contribute up to £4,000 a year (topped up by the government to £5,000) so this will use up some of your £20,000 ISA allowance. With AP, you can purchase a maximum of £6,500 of additional pension. How much this will cost will depend on your personal circumstances. Get a quote from your pension administrators. One factor is age. The sooner you purchase, the better the return on your money.
The final point I’d add is: Do you want a guaranteed inflation proof income for life?
With a LISA, assuming you invest it, the return is not guaranteed. With AP, it is guaranteed because it gets added to you career average or final salary pension. It will continue to increase at least by inflation and there may also a spouse benefit should you die. However, this also depends on the return you will get. If the quote you get back provides a poor return on your investment, then maybe even with the guarantee, the LISA will win.
Note: don’t be shocked by the quote. It might seem like a lot of money, but whether or not it provides value will depend on the return on your investment. Do the maths before deciding.
Maybe a balance could be a little bit of both.
I intend a more detailed post about this including points which I’ve missed but didn’t want you to wait until then in case you’re hoping to make a decision soon.
I hope this gives you a start and do let me know what you decide.
As always, DYOR and note my Disclaimer.
PS. Reference the FED. As you know, they’re made up of cops just like us and we (Police Officers) are in general just as bad (if not worse) at managing our money than the general public. It doesn’t surprise me that we are not told about this. It’s a shame, so please pay it forward and let our colleagues know about the benefits of FI.
Hi. Thanks for the quick and very detailed reply. So rare to speak to someone in the job who A. likes to talk about finance and B. actually knows what fire is.
So to clarify. When I say FI at 55 I mean that to include my police pension, actuarialy reduced in value.
So my investment mission is to plug the gap between my reduced pension and my cost of living it would be nice to have around £40k (still have a mortgage to pay). My actual number is £38k but I’m building in some margin for error. Especially as I’m not including my wife’s pension (LGPS) or state pension.
So far I have maxed my Lisa for the last 2 years and on top am putting alway as much as I can into my standard isa. This is Due to the age restrictions of Lisa.
I have a SIPP but stopped paying into that a few years ago.
After reading your post the immediate thing to strike me is that if I divert my LISA £4K into additional payments into my police pension and top up to the max, then at 55 I should have a good chance to get to £40k. I should get a proper forecast and get accurate figures from the HO website. What are you your thoughts on this?
Yeah, I do enjoy talking about finances and like you, I could not find anyone at work interested in this stuff so I decided to start this blog.
I see. Our of interest, which scheme are you on? 2015 or 2006?
I assume the £38k per year expenses are the combined expenses between you and wife including the remaining mortgage?
So if I understood correctly, the gap you are aiming to fill is: living expenses minus reduced police pension from the age of 55?
In that case, a LISA would not fit this criteria. You can only withdraw at an older age although you can withdraw earlier (with a hefty fee). With a SIPP you can currently withdraw at 55, but this is changing.
So this only leaves you five main options as far as I can see:
1) ISA; 2) AP; 3) SIPP – depends on when you plan to withdraw due to changes; 4) other form of income (part-time work, property investment, etc); 5) reduce your expenses.
My understanding of AP is that the contributions made for each scheme year is added to your main police pension at the end of the scheme year. Which, if you decide to leave at the minimum age of 55, then the AP you purchased should be similarly reduced in line with the main police pension. You will need to confirm this!
As to whether or not you should be investing in an ISA / SIPP and what to invest in? That depends on the time horizon and your risk tolerance. How far off are you from 55?
So, my thoughts are this.
1 – Get an accurate quote from your administrators as to how much pension you can buy for x amount.
2 – Then confirm with them whether or not you can access the AP at the minimum age of 55 just as you can with the main pension.
3 – Get a forecast from them as to how much it will be reduced by.
Depending on your pension administrators, points 1 and 3 can be done online to give you an approximate figure. I know I can, so may you could to.
Should you continue to pay into your LISA or perhaps consider paying into your SIPP again? There is free money to be had in both, but if your budget is such that it can only be one thing, then a LISA does not plug the 5-year gap you need. With a SIPP? Well it depends.
I would recommend getting some proper financial advice before pulling the FIRE trigger – it needn’t be expensive and can sometimes be free. This is what I intend to personally do as well; if only to provide me with some reassurance that I haven’t messed up my numbers somewhere or missed something out.
I had 11.5 years in the 1987 scheme before moving over. I just logged onto the force pension calculator, it’s down! Grr. Although I noticed that the home office calculator appears to now be more sophisticated and calculates actuarial reduction from 60.
I think I can work out my 2015 entitlement relatively easily by assuming 2% CPI.
1987 scheme can be worked out using last year of my current rank.
I’d really like to discuss merits of going at 55. I mean I get fire but the 12/13 period to wait by leaving early is significant.
On another note. Would you happen to have an email address I could write to?
Ps west mids here.
I’ll email you.
Sorry lazy comment my end…
I am actually joining the MET as a direct DC following 13 loveless years doing admin stuff in financial services.
Does the police have any policy on transferring old company pensions in?
Thanks (just need to read all your other posts now)
Congratulations and welcome to team blue.
No policy as such. You will need to contact the MET’s pension administrators and get a transfer-in quote. If it is a private company pension, then be prepared for it to be valued less once transferred in than you might expect.
This is because the Police pension is still relatively good compared to private sector pensions. Allowing retirement as early as 55 and more than inflation protected whilst a member amongst other things. As a result, I see many people get surprised by the quote.
Seek professional financial guidance if unsure on anything.