How to nurture a nest egg

April 14, 1995

THES reporters unravel the tangle of pension options facing staff three years after the reorganisation of higher education and examine the barriers to a unified system. In the university business school in which I was working until lately, life was enlivened earlier this year by the arrival of the Man from the Pru. We were told that the Prudential Assurance Company was the concern chosen by the Department for Education to offer supplementary pensions, based on additional voluntary contributions (AVCs), to us as ex-polytechnic members of the Teachers' Superannuation Scheme.

Anyway, armed with the internal telephone book, our particular Man from the Pru contacted everybody. I do not know how many pension plans he actually sold though he soon, it was said, became a sort of father confessor or agony aunt, triggering off the stories of everyone's frustrations about money, rising student numbers, falling standards, macho management and desires to get out of it all.

I did not go to see him as I was already well into the process of retiring and it was too late for me to think about new pension arrangements. But as someone who had taught finance, I did get asked my opinion about the merits of the various pension schemes and of extra pension contributions generally.

To my shame, perhaps, I was pretty ignorant about it all at that point, but I have been looking into it since, and what follow are some thoughts about what everyone in the TSS - and, to a large extent, in the old universities' Universities' Superannuation Scheme (USS) as well - ought to bear in mind.

By far the most important fact is that, if possible, anyone in any steady job, not just teaching, ought to be paying the maximum tax-deductible proportion of their salary, which is 15 per cent, into a pension scheme. This is because of the tax advantage involved. Pension scheme contributions up to the permitted level are wholly deductible from your salary before income tax is calculated. If you are a standard rate (25 per cent) taxpayer, this means that for every three pounds you put into a pension scheme, the Inland Revenue effectively adds a fourth.

Take a simple example, of a middle-aged, male senior lecturer earning Pounds 25,000 a year in a new university. He will normally be contributing 6 per cent of that, Pounds 1,500 a year, to the TSS. But he could contribute a further 9 per cent, or Pounds 2,250, to the TSS or to an insurance-based pension. Because of the tax saving, the net cost to him of either course would be only Pounds 1,687.50, implying an immediate gain of Pounds 562.50. Put it like that, and he would be daft not to do one or the other.

Ah, you may say, but in practice he is probably hopelessly strapped for cash. He and his wife or other partner, who may well be a teacher too, knowing only too well the deficiencies of the public education system, have committed all their money to private school fees for their children, and could not possibly spare the Pounds 1,687.50 in question.

Well, this may be true, but do they not have a house? Unless it is mortgaged to the hilt already, it would pay them handsomely to borrow against it in order to pay the increased pension contributions. To avoid worry about variable rates, they could borrow the Pounds 1,687.50 at a fixed rate of, today, about 8 per cent, or Pounds 135 per year, and make the return of Pounds 562.50, an immediate profit of Pounds 4.50.

This is, of course, a simplification. The mortgage debt will still be there next year requiring to be serviced, and next year's additional pension contribution will also need to be financed in the same way, and so on. But the money in the pension scheme will be earning a return which will more or less match the mortgage interest, so that each year's initial, massive gain will not be lost. For professors and other fat cats whose marginal rate of income tax is 40 per cent, the argument is even stronger. For every three pounds they put into a pension scheme, the Revenue adds a further not one, but two pounds.

All this leaves the question: which supplementary pension scheme should you choose? This is not simple to answer. The TSS is a final-salary-based scheme: you get an annual pension of one-eightieth of your final salary for each year which you have served. You can also use AVCs to buy added years in the TSS (up to a career total of 40, served or purchased) out of current salary up to the 15 per cent limit. The pension is linked to the Retail Price Index under the Pensions Increase Act of 1971.

The official alternative, organised by the Department for Education as far back as 1989 (though I at least had not taken it in until lately) is the Pru's AVC scheme. Your university or college will deduct contributions from your salary, which go towards an accumulating pension fund provided by the Pru on ordinary insurance principles involving the payment of bonuses based on the company's investment returns. When you retire, you can choose what sort of pension you want the fund to be put to: fixed, index-linked, providing or not providing for dependents, and so on.

If you prefer, you can set up an AVC scheme with another insurance company, on the same basis. In that case the arrangements for paying the premiums and getting the tax benefits are slightly more elaborate, but apart from that it is just the same as with the Pru.

The real choice is whether to go for the added-years scheme or for an insurance-based one. If you are in a low grade but expect to be promoted in the more distant future, the added-years option is the more attractive: you will be paying cheaply now for relatively handsome future benefits. Otherwise, however, it is a moot point, depending partly on the movement of the stock market, which will determine the profits and bonuses of the insurance companies.

Two final points: first, the TSS with its legally-entrenched index-linking appears to be as safe as the Bank of England. But with more and more people living into old age, the burdens on the public purse are growing, and some future Government could always change the law and raid the public pension schemes. A key principle of finance is diversification or, in plain English, do not put all your eggs in one basket. Therefore it may be wise, especially for younger people, to choose an insurance-based scheme for AVC's, rather than the TSS.

Second, do not confuse AVCs with the choice, made available under Thatcherism, of opting out of the TSS or other employer's pension scheme in favour of your own personal scheme. This is highly inadvisable, because you lose the employer's contributions to your pension. The insurance companies, including the Pru, were rapped last year by their regulator for over-selling this option to nurses, teachers and other public servants, and are probably (though there is a legal case pending) going to have to pay compensation for reduced pension prospects to the thousands of people involved.

Michael Connock

Former financial journalist and economics lecturer in one of the new universities, now a pensioner.

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