‘You Asked’ is a series of insights from the boosst team. You, our clients, have a wonderful ability to ask relevant and thought-provoking questions… which are often (but not always!) related to financial planning. boosst is a trusted source of knowledge and independent advice, so it makes sense that you come to us with a broad range of questions – which can vary from ‘Which car should I buy?” to “What’s the best way to teach our children about money?”.
This ‘You Asked’ post was written by Tom.
You Asked: What is the McCloud Judgment and how will it impact my Final Salary Pension?
Many a nurse, surgeon, policeman, firefighter and teacher will tell you that one of the greatest benefits of being a civil servant is the very generous Defined Benefit (Final Salary) pension that they look forward to receiving in retirement. Traditionally for every year you worked, you earned a proportion of your final years’ salary, paid to you in retirement. The amount you receive is based upon a proportion of your last years’ salary, so the more years you served, the greater income you receive. Historically, a career NHS worker who was retiring with 40 years service and earned £60,000 in their last year of work could expect to receive an annual pension of £30,000 from age 60. This type of Defined Benefit pension increases annually with inflation for the rest of their life and will be paid every year until they die. This is a very valuable benefit and has been very expensive for the NHS to provide. This type of Defined Benefit (more commonly known as Final Salary) pensions are rightly known as the ‘Gold Plated’ pension.
Providing such generous benefits costs government a small fortune. Funding this type of pension has become unsustainable as the population of retirees has grown… so pension schemes needed to start making changes to how much is contributed (by the individual and their employer) and how the retirement income is calculated.
In 2011, ahead of the budget, a review of public sector pensions was requested in an attempt to reduce the future cost burden. A new scheme was introduced (later labelled the 2015 scheme), with two significant changes. The first was to change the way the final entitlement is calculated, moving from a ‘Final Salary’ basis (when you are likely to be earning the most) to a ‘Career Average’ basis (known as CARE). This change seems sensible, as the Final Salary basis doesn’t relate very well to the contributions a member has paid. Using the example of a teacher, the member could be making contributions based on a lower salary throughout most of their career, before climbing the ranks to become a headmaster for the final years of their career. Under a Final Salary basis, the pension paid in retirement is based upon the headmaster pay level, even though they only paid contributions based on that salary for a year or two. Now, the Career Average entitlement is being accrued each year and is linked to the salary earned each year and the contributions the member paid.
Some members also found themselves caught out by the Final Salary basis if they moved to a less senior role shortly before retiring… as their pension was then based on the lower salary. Some schemes (notably the NHS) introduced ‘Pay Protection’ to stop members from inadvertently reducing their pension entitlement but this has to be applied for within 3 months and is often missed. This isn’t ideal. Pension rules should not discourage or make it difficult for our best people to step down the pay scale as they transition to retirement. These pension rules, alongside the complex Annual Allowance and Lifetime Allowance rules, have encouraged many senior NHS workers to step directly into retirement and have contributed to the skills shortage we often hear about in the news.
The second change is the age at which you could start to receive your pension income, with many schemes moving from 60 or 65, to State Pension Age (between 66-68).
These changes would apply to all except for those qualifying for either Transitional or Tapered protection, who were within 10 years or between 10 – 14 years from retirement respectively. These protections meant that members either didn’t move to the 2015 scheme, instead staying in their ‘Legacy’ Scheme, or were deferred from moving over. These two changes were approved and introduced in 2015.
Was there no alternative to these changes?
Not really. The Final Salary system was unsustainable as the retired population grew. These changes enable the public sector to continue offering a Defined Benefit pension. Although losing the ‘Final Salary’ benefit and moving to ‘Career Average’ feels like a backwards step for public sector workers, the good news here is retaining the Defined Benefit structure. For context, in 2011 the private sector had faced identical funding challenges for the small number of companies that were still offering their own Final Salary pensions. As an example, BP had already closed their Final Salary pension to new employees in 2009 and in 2021 they closed the scheme for further accrual; meaning all scheme members were evicted and now have a standard ‘money purchase’ workplace pension. The cost of running a Defined Benefit pension (be that Final Salary or Career Average) is an enormous liability. To quantify what it costs to run a Final Salary pension; the British Airways Pension Fund holds enough assets (£21.5 Billion) that it could buy every asset owned by British Airways… and have a cool £4 Billion cash leftover.
So, what exactly is the McCloud Judgement?
It wasn’t long (December 2015) until an employment tribunal ruled that these protections were unlawfully discriminating by age, as they were financially favouring older members over younger ones. The government appealed the decision, however this was rejected in July 2019. A year later the government formed a committee to propose how to rectify the discrimination. A ‘Remedy Period’ was introduced, which identified the period during which members were impacted by the changes, from April 2015 to April 2022. This decision and its subsequent ramifications has come to be called, ‘The McCloud Judgement’ or ‘The McCloud and Sargeant Judgement’ after the Judges and Firefighters that brought about the case.
Who does this affect?
Any Public Sector worker – teacher, NHS staff, Civil Service, Police, Fire or Armed Forces member, who was enrolled in the pension scheme on or before 1st April 2012 and was still enrolled on 1st April 2015. This can include current active members, those already retired, and even those that have since passed.
What is the impact?
The proposed remedy is that all eligible members will be contacted at the time of their retirement and be offered a choice, with those that have already retired, or the recipients of those that have passed, (titled as those in ‘Immediate Detriment) being contacted immediately (before 1st October 2023).
If you are impacted, you will have the following choice:
Would you prefer to accumulate benefits under your previous legacy scheme (Final Salary) or the new 2015 scheme (Career Average) for the remedy period (April 2015 to April 2022)?
The two options will be presented side by side, so that you are clear of the options and can make a decision.
How can financial planning help me with this?
If you are a boosst client, you can relax. We will review your options and help inform your decision.
If you are not yet a client, but feel you should seek advice after reading this, please contact us. We can setup a call for you with one of our financial planners to explore your current position and explain how our services can help you navigate this and other financial decisions that you will face over the coming years.
Whilst it might seem simple to pick one of two options, there are a myriad of complexities between the schemes themselves, as well as your own personal circumstances to consider, not to mention that you have limited time to make this irreversible choice, so this really is something you want to be certain of, having considered all immediate and future implications.
For boosst clients;
- We are on hand to discuss the two options when you receive them.
- Our the full boosst clients can use their detailed cashflow planning software to model the impact of each option, simplifying the decision.
- We will consider how the revised pension income will impact how you best utilise your other assets, to achieve your goals.
- We can highlight shortfalls in income where pension access has been delayed from age 60.
- We will consider your most efficient options for providing retirement income if your retirement age has been pushed back.
- We will consider longer term implications, such as the impact on your Lifetime Allowance, pension death benefits and estate planning.
boosst final takeaways…
- Whilst on the surface the choice might seem simple (A or B… whichever gives more income!), there are in fact other considerations to take into account and there is no simple answer across the board.
- Working with a Financial Planner, who has helped identify your goals and objectives, will put you in a much better place to identify the best choice for you.