From: Ronald Raygun 
Subject: Re: how much reduction is typical for early retireees pension?
Newsgroups: uk.finance
Date: Thu, 21 Jun 2007 21:29:57 GMT
Bytes: 4646

Tim wrote:

> "RobertL" wrote
>> My employer's scheme reduces my pension by 1/3% for each
>> month I retire earlier than my 60th birthday.  So that's 4% per
>> year, which seems OK.  but this is provided I am still emppoyed
>> by the company at the time I retire.  But  if I am not employed with
>> the company they reduce it by  1/2% per month. (6% per year).
>>
>> I cannot see how the actuaries would justify that.  ...
> 
> It's actually perfectly justifiable, and in fact to be expected...
> 
> It's all because of the increases that would be granted between
> the proposed early retirement and normal retirement.  The 4%pa
> reductions for "active" members allow for the fact that the current
> pension is effectively increased upto normal retirement by salary
> increases (as the pension is based on final salary at normal
> retirement date).  Salary increases are generally accepted to
> have been around 2%pa more than inflation over the longer term.
> 
> However, for "deferred" members, their current pension would
> only generally be increased at (around) inflation between now
> and normal retirement.  In other words, the pension that they
> are giving up (from normal retirement), to get the reduced
> early pension now instead, is 2%pa less than the "4%pa
> reduction factors" allow for.  So it would need to be reduced
> by another 2%pa if the 4%pa factors were to be used;
> it's easier just to use the 6%pa factors in the first place!

Could you run that by me again, slowly?  It seems to me you've
added 2% which you ought to have subtracted instead.

Please consider the following illustration:

Members A and B, who are contemporaries, would both normally
retire at 65 with 40 years' service under their belts.

Member A decides instead to retire at 64 with 39 years service.
Compared to staying on until 65, he suffers a 2% reduction due
to missing out on a final salary increase, a further reduction
of 2.5% due to losing one year's pensionable service, and a 4%
actuarial reduction on top.

Member B ceases employment at 63 with 38 years service and
becomes a deferred member, initially planning to draw his pension
at 65.  This costs him a drop of 4% in pensionable salary and 5%
due to losing 2 years' pensionable service.  Fair enough so far.

Later he decides to draw his pension one year early, from 64,
because his pal (member A) has persuaded him to join him for
some gentle hillwalking in the Himalayas.

What justifies him losing an additional 6% instead of 4%?

If the reduction is purely actuarial, then the only consideration is
that the pension -at whatever level- will be payable for one year
longer than otherwise.

But there is another consideration, and that is that the pot fed by
pension contributions will be smaller for B than for A.  Their
contribution records for the first 38 years of their service are
the same, but A has paid an additional year's worth.  If the average
pension fund growth per annum is more than 2% above inflation (and
it usually is, isn't it?), then A's fund will be roughly (but slightly
less than) 39/38 as big as B's and this would therefore justify A's
pension being 2.6% more than B's, when all is said and done, given
that they are being brought into payment at the same time as each other.

Yet A's is 8.5% less than if he'd stayed on to 65, and B's is 15%
less.  That doesn't seem right to me.  Does it to you?  If so, how?