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Pension Jargon Buster

The pensions debate can be full of technical jargon, often leaving people scratching
their heads at some of the jargon used.

This jargon buster is designed to help you get round that and help you understand
some commonly used pension terms and what they mean.

Public sector pension scheme
A pension scheme for workers in the public sector – central government, local
government, the NHS and other statutory bodies – but they may also have members
working for private companies providing public services (see ‘Admitted bodies’).

Active member
A worker who is paying into a pension scheme.

Accrual rate
In a defined benefit pension scheme (see below), this measures the rate at which a
member’s pension builds up.
It is usually written as a fraction or a percentage of pensionable pay (for example, a
1/60th accrual rate is the same as 1.67%), which refers to how much pension you get
for each year you’re a member of the scheme.

If the accrual rate is 1/60th, you will get 1/60th of your final pensionable pay (see
below) for each year of your qualifying service. So, after 30 years pensionable
service, you earn you half your final pensionable salary as your pension.

For example, if your final pensionable salary was £30,000, 30 years of paying into
the scheme would man a pension of 30/60ths, or one half, of that salary, or £15,000
a year. Similarly, 10 years service would get you 10/60ths, or £5,000 a year.

Actuaries
Financial and statistical experts who calculate the cost of the pension scheme,
making judgements about its value and liabilities, and work out how much needs to
be contributed to pay for the pensions that are being built up in the scheme.

The do this by estimating how long they think members will live in the future, and
predictions of average pay increases, inflation and how much will be earned from
investments.

Pensions schemes undergo a regular ‘actuarial valuation’. This happens every three
years in the Local Government Pension Scheme and every four years in the NHS
scheme.

The actuaries will then decide whether they need to change any of their assumptions
about life expectancy, earnings etc. The will also decide on how much the
employer’s contribution should be, until the next valuation.

Additional voluntary contributions
Often referred to as AVCs, these are extra contributions, over and above what
members normally pay. Occupational pension scheme members may choose to pay
these to get extra pension benefits when they retire.

Admitted bodies / admitted body status
Public service pension schemes have rules on which employers can join the
scheme. This can include employers that are not part of the public sector.

In the Local Government Pension Scheme, for instance, the ‘admitted bodies’ may
include many types of voluntary-sector organisations and even private sector
employers.

These employers can apply to join the LGPS if they take over a public service, which
means their employees will stay in the LGPS even though they don’t work directly for
a council.

Basic state pension
A flat rate pension, payable from the state pension age, that is paid to everyone who
has made the minimum of National Insurance contributions. The minimum number is
30 years and the maximum basic state pension in 2011/12 is £102.15 a week for a
single person.

Career Average Revalued Earnings (CARE) pension schemes
Like final salary pension schemes (see below), these are ‘defined benefit (see below)
pension schemes where the pension a member gets depends on their wage and
how long they are a member of a scheme.

In a CARE scheme, you still get a proportion of you salary as a pension when you
retire (the proportion depends on the accrual rate) – but instead of the final
pensionable pay (see below) being based on earnings near retirement as in a final
salary scheme, it is based out on how much you earn in each year you’re a member
(adjusted for inflation).

So if you’re in a career average scheme with an accrual rate of 1/60ths and pay into
it for 30 years, your pension will be 1/60th of your first year’s salary, plus 1/60th of
your second year’s salary, plus 1/60th of your third year’s salary etc, all the way up to
1/60th of your final year’s salary.

Obviously, inflation means that what you earned 30 years ago will be worth very little
now, so the pensionable pay for each year is increased, in line with either inflation or
average earnings, until you retire or leave the scheme.

Commutation
This is where a member gives part of their annual pension (normally up to a
maximum of 25%), in exchange for an immediate tax-free lump sum when they retire.

Cost sharing
All the public service pension schemes were reformed in 2007/9, with an agreement
that, in future, members would share any increases in the costs of the schemes,
especially when it came to people living longer.

In the NHS Pension Scheme, employers’ contributions are capped at of 14.2% of
salary – if costs rise higher than this because of increased life expectancy, then
members’ contribution will be increased to pay for them.

There is no agreed cap on employers’ contributions in the Local Government
Pension Scheme.

However, the government has suspended these cost sharing agreements while it
tries to push through major changes to the schemes.

Deferred member
A member who is no longer contributing to the pension scheme, but is due a pension
from the scheme when they reach normal pension age.

Defined benefit (DB) pension scheme
This is where the rules of the scheme decide how much pension you will get – in
other words, the benefits are defined.

There are different ways of working this out, but members will know which method
their scheme uses and can work out what their pension will be.

For instance, in the examples used above of a scheme with an accrual rate of
1/60ths, it is 1/60th of your pensionable salary times the number of years you’ve
been in the scheme.

Both final salary and career average schemes (CARE) are defined benefit schemes.

Defined contribution scheme (DC)
As the name suggests, this is a pension scheme where how much you pay in each
year – the contributions – are defined, but the pension you get at the end – the
benefit – cannot be predicted.

They are also called money purchase schemes.

Essentially how these schemes work is that a worker (and sometimes their
employer) pays money into an individual pension pot. This money is then invested
until you come to retire, when it is used to buy an annual pension, or ‘annuity’.

How much that pension is will depend on a number of factors, mainly:
• how much money is in your individual pension pot (this won’t simply be the amount
you put in – but will depend on investment income, whether shares the money has
been invested in have gone up or down in value, and what charges have been made
for managing that investment);
• what sort of annuity is available to buy at the time you retire – which will depend on
something called the annuity rate, or how big an annual pension a given pot of
money will buy at any one time.

Basically, if someone retires when the stock market is high, they are likely to get a
better pension, for the same amount of money, as someone who retires when the
market is low. Charges can also mean for every £1 paid into the scheme, as little as
40p is available to buy a pension when you retire.

Early retirement
This is when a member retires, and collects their pension, before the scheme’s
normal pension age.

Taking your pension early will usually involve an ‘actuarial reduction’ – in other
words, because you can be expected to be drawing your pension for longer, you will
get a smaller amount each year.

Fair Deal
In 1999 the government set up the ‘Fair Deal on Pensions’, which means private
sector employers taking over public service workers have to provide a pension
scheme which is ‘comparable’ for the public service scheme those workers are
forced to leave.

It also allows workers to transfer their public service pension to the new ‘comparable’
scheme at special rates.

The Local Government Pension Scheme also allows private-sector employers join it
(see admitted bodies above), so workers can stay in the LGPS after they have been
outsourced, rather than having to join a comparable scheme.

Final pensionable pay
This is the pensionable pay that is used to calculate your pension when you retire
from a defined benefit scheme.

In a final salary scheme, it is usually the pensionable pay you earn in the last 12
months of work, although there are variations.

In the new NHS Pension Scheme, final pensionable pay is an average of the last
three years.

Final salary scheme
A final salary scheme is one where your pension is a proportion of your pay near to
retirement, as opposed to a career average scheme (see above) that calculates a
pension on your average earnings over the whole time you’ve been a member of the
scheme.

The Local Government Pension Scheme and NHS Pension Scheme are both final
salary schemes: the pension you get is linked to how long you’ve been in the
scheme and what your pensionable pay was when you leave it (either to retire or to
change jobs and become a deferred member (see above)).

Funded scheme
A pension scheme where the contributions from members and employers are put
into an fund, which pays out pensions and benefits as they fall due, and which is
invested to earn extra income.

The Local Government Pension Scheme is the only “funded” public service pension
scheme.

Ill-health early retirement
This is where a member retires early because of ill health. They may get higher
pension benefits than a member normally gets when they retire early.

Index-linked pensions
This is where a pension that is being paid, or a pension that is left behind in a
scheme when a member leaves employment, is increased each year by the general
increase in the cost of living – ie, by inflation, usually measured by either the Retail
Price Index or the Consumer Prices Index.

Investment
This is when the money paid into a pension scheme is used to buy things like
shares, bonds (a loan, usually to governments, at a fixed rate of interest and for a
fixed period) and properties to get more income into the pension funds.

Liabilities
These are amounts, which the pension scheme will have to pay now or at some time
in the future.

The most common liability is paying a member’s pension benefits. Total liabilities
include the total pension payable to every member of the scheme for as long as they
live – on its own, this can be a scarily big number, but libilities need to be looked at in
relation to income and the amount of time over which they are due.

Lump sum cash payments
Members of public service pension schemes will often have to take part of their
pension benefit as a cash lump sum at retirement. All members can decide to
exchange more pension for a one-off cash payment at retirement (see Commutation
above), subject to certain restrictions. These lump-sum payments are tax free.

Opting-out
This is where a member decides they don’t want to join, or no longer wish to remain,
in their pension scheme.

Pay as you go (PAYG) schemes
A public-sector pension scheme where benefits (pensions) are paid out of current
income (contributions). There is no separate fund with money in it. These are also
often referred to as ‘unfunded schemes’.

Employer and member contributions are paid to the Treasury and money is released
from the Treasury to pay pensions.

Although there is no dedicated fund, the contributions paid by members and
employers are based on what would be needed if the scheme was funded to cover
benefits as they are earned. The NHS Pension Scheme is a pay as you go scheme.

Pensionable pay
The pay that you pay contributions on as defined in the rules or regulations of the
pension scheme. Final salary schemes usually exclude overtime and one-off
payments.

Preserved or frozen benefits
These are the benefits an occupational pension scheme member has already earned
from the scheme when they stop being an active member (because, for example,
they change jobs) – or if the scheme closes – before their normal pension age.

The member will then get these preserved benefits when they retire, increased by
inflation according to the particular scheme rules.

Pension fund
This is the money saved and turned into assets of the pension scheme.

Pensioner
Someone currently receiving a pension from the scheme they previously paid into.

State second pension (S2P)
An additional stte pension on top of the basic state pension. At the moment, this is
related to earnings and used to be called the State Earnings Related Pension
Scheme, or SERPS.

Members of both the Local Government Pension Scheme and NHS Pension
Scheme are unlikely to get a state second pension for the period thy are members of
these schemes, because they are “contracted-out” of the state second pension.

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