The magic of compound interest

12th January 2001 at 00:00
Paid off your student loan? Well, now it's time to pay for your pension, writes Susannah Kirkman. And though teacher pay may be dismal,the pension schemeis not bad at all.

If talk of "lump sums" and "accrued benefits" brings you out in a cold sweat, don't worry. To join the Teachers' Pension Scheme, all you have to do is get your first full-time job and you're automatically a member of this rock-solid, index-linked scheme. You may, however, want to know more about how it works, so here are the answers to the most frequently-asked questions: Why stay in the Teachers' Pension Scheme?

It would be a big mistake to set up your own pension with a private company, as 8,000 teachers found to their cost in the 1990s when they were persuaded to leave the teachers' scheme. The companies who mis-sold these pensions have since been forced to pay for the re-instatement of the teachers to the state scheme.

Funding similar provision through a private pension would cost you hundreds of thousands of pounds. As a teacher, all you pay is 6 per cent of your salary, while your employer pays 7.4 per cent. When you retire you get an index-linked pension and tax-free cash - a "lump sum".

Both the pension and the lump sum are based on your salary in your top-earning year in the three years leading up to your retirement. And the best news is that all this is guaranteed - the pension does not depend on the ups and downs of the stock market, like a private pension, and will increase after you retire, related to rises in inflation.

What's a pension worth?

Someone retiring today on an average salary of pound;22,000 after 37 years in teaching would get around pound;10,175 a year, plus a tax-free sum of pound;30,525.

What are the benefits for teachers' families?

Young teachers with families should look at extra cover, says Barry Fawcett, head of pensions at the National Union of Teachers (see AVCs, opposite page), particularly if they are not married.

So far, the teachers' scheme does not offer any benefits to unmarried partners. And pensions for dependants are based on the length of your service, so your family may not get much if you haven't been teaching long.

If you die before you retire, your spouse will receive a death grant of twice your average salary. Your widow or widower will also be paid a short-term pension for three months, equivalent to your monthly salary. If you have children, they will receive the same short-term pension. And, if you have been working full-time for more than two years, your family will get a long-term, inflation-proofed pension.

The widow or widower of a teacher on pound;25,000 with 10 years' service would get a pension of pound;1,562.50 a year, for instance. If there are two or more children, they would receive the same. If you die after you retire, your spouse will get a short-term and a long-term pension, based on your average salary and your length of service. So anyone who has built up 40 years' service since 1988 will be able to hand on 50 per cent of their pension to their widow or widower.

Why think about pensions now?

If you're still paying off a student loan, the last thing you may want to contemplate is your pension. But for those who want to ensure a comfortable retirement, the magic of compound interest means the earlier you start topping up your pension, the more it will be worth.

Additional voluntary contributions (AVCs) will give you more the sooner you start to contribute, while the "past added years" scheme costs far less if you start paying while you are on a low salary (see next question). And teachers who are not eligible to join the teachers' pension scheme should consider their options carefully - the longer you wait before setting up a pension scheme, the more expensive it becomes. If you rely on a state pension, you may be left with very little in retirement as the value of the state pension in relation to average earnings has plummeted overthe past 20 years.

How can teachers top up their pensions?

There are two main ways: you can either pay AVCs or buy additional years of past service (past added years). Your AVC contributions are invested in funds managed by the Prudential, which runs the AVC arrangements for the Teachers' Pension Scheme. You can put up to 9 per cent of your salary into AVCs with full tax relief, so every pound;1 you pay is costing you only 75p. One advantage of AVCs is that you can use them to boost benefits for your family after your death. You can use your contributions to increase the lump sum your dependants will receive to up to four times your earnings, and the widow's or widower's pension up to two-thirds of your own. In future, teachers earning less than pound;30,000 may also be able to top up their contributions through a stakeholder scheme, which offers lower fees and greater tax advantages than an AVC.

Buying "past added years" provides guaranteed benefits which aren't dependent on investment returns, like AVCs. This is how it works. To get the maximum pension possible under the teachers' pension scheme, you would have to work full-time for 40 years, which is virtually impossible as most teachers don't start their careers until they are at least 22. Purchasing past added years gives you the chance to buy in the pension benefits of the missing years of service. The cost is based on your age and salary when you start to make payments, so the sooner you start, the less it costs.

Another option is to buy "free-standing" AVCs (FSAVCs), which means you can choose the company which invests your extra pensions savings. Although these schemes offer more flexibility - the benefits can be withdrawn from age 50 onwards, for instance - the costs are often far higher than for AVC schemes and relatively few teachers have invested in them.

What about part-time teachers?

If you are part-time, you are not automatically a member of the Teachers' Pension Scheme - you must apply to be included. Write for Form 261 from your employer or from Teachers' Pensions (address below). The good news for part-timers employed on a regular contract is that their pension is now based on the average salary they would have received as a full-timer in the same job.

What about supply teachers?

Supply teachers employed by schools and colleges must also apply to be included.

Supply teachers who work for private supply agencies are classified as self-employed, so they have to make their own pension arrangements. In future, these teachers may be able to pay in to a stakeholder pension if they earn less than pound;30,000.

And mature entrants?

You can transfer contributions to any previous occupational pension scheme to the teachers' scheme, but you must do this within one year of starting your first teaching job.

Where should teachers go for information and advice?

For information on the Teachers' Pension Scheme go to the pensions department of your union. These union advisers understand every twist and turn of the TPS. They are the unsung heroes - and heroines - who baled out many of the teacher-victims of mis-sold pensions.

Unions like the ATL also have an excellent range of leaflets explaining aspects of the teachers' scheme. But they are not allowed to give financial advice. For this, the best option is to seek out an independent financial adviser. Try to find one who is salaried, rather than paid on a commission basis, if you want to ensure their advice isn't being coloured by the commission they stand to gain.

Improving your Pension Prospects - 15 leaflets on various aspects of the Teachers' Pension Scheme, available from the Association of Teachers and Lecturers, 7 Northumberland Street, London WC2N 5DA. Tel: 020 7930 6441.Your Pension - A Guide to the Teachers' Pension Scheme, England and Wales, is available from Teachers' Pensions, Mowden Hall, Darlington DL3 9EE. Tel: 01325 745745.

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