Andrew Warwick-Thompson answers your questions.
Q I am a teacher in full-time employment with a salary of Pounds 25,000. I am 56 this June and at 60 (1999) I shall have clocked up 16 years' teaching so I am looking at how best to supplement my pension. Should I: (a) buy back added years; or (b) invest in additional voluntary contributions? My mortgage goes on until I am 64 and I am going to continue working until then; instead of topping up my pension, should I try to reduce my mortgage of Pounds 31,000 (endowment)?
A As I have explained in previous weeks, there are two methods of buying "added years" in the Teachers Superannuation Scheme (TSS). Method A (periodical deductions) and Method B (lump sum). Alternatively, you can pay "additional voluntary contributions" (AVCs) to the Prudential, the insurer which provides the TSS AVC contract. If you buy added years your payments secure additional, guaranteed pension from the TSS at the rate of 180 of your final salary at retirement for each extra year bought. The additional pension so secured includes all of the "extras" included in your service-related pension, eg a spouse's pension and inflation protection.
Based on your current salary and the service you will have completed at age 60 your initial service-related pension will be 1680 x Pounds 25,000 = Pounds 5,000. (Of course, your actual pension at age 60 will be based on your then current salary). Each added year that you purchase is, therefore, worth about Pounds 312.50 of extra pension in 1995 money terms, plus the "extras".
If, on the other hand, you pay AVCs there is no guarantee on the level of additional pension you will be able to secure at age 60 - the benefits are secured on a "money purchase" basis, ie the amount of additional benefit secured will depend upon the level of contributions you pay, the investment return net of the contract expenses over the term to retirement and the open market rate at which pension can be bought when you retire. The cost of buying a pension of Pounds 312.50 at age 60 will be about Pounds 5,160 in 1995 money terms.
In order to judge which approach is best for you, you need to consider the following: The cost factor: the cost of one added year versus the cost of AVCs at a rate sufficient to exactly replicate the benefit of one added year, ie the rate of contribution necessary to secure an AVC fund of Pounds 5,160 at age 60. The TPA can provide you with the cost of added years and either the Prudential or an independent adviser can tell you the AVC rate required.
The risk factor: if you buy the added years the TSS guarantees to pay you a pension equal to 180 of your final salary at age 60 plus the "extras" indicated above.
However, if you pay AVCs there is no guarantee on the level of pension you will be able to buy at age 60 - it could be greater than or less than the pension secured by buying added years, depending on investment conditions between now and age 60 and the price of pensions at age 60.
Concerning your mortgage, I think that you should let it run until the normal redemption date. You have an endowment policy which should pay off the loan at the redemption date, but which will almost certainly represent poor value for money if you were to stop paying the premiums to it now. Also, it is probably more tax efficient to pay pension contributions than to reduce debt.
Andrew Warwick Thompson is a lawyer who works for Bacon and Woodrow, the international firm of actuaries and consultants. Readers may put questions to him (no names published) should write to Personal Finance Desk, The TES, Admiral House, 66-68 East Smithfield, London E19XY. No personal correspondence will be entered into and no legal liability accepted for advice offered.