Remind me, what is the problem?
The March 2016 actuarial valuation of the Teachers’ Pension Scheme (TPS) by the Government Actuary’s Department revealed that the scheme was £22bn in deficit, £7bn up from 2012. Economic conditions and increased longevity were the main reasons.
The employer contribution rate of 16.48% rose to 23.68% (September 2019) – a 43% increase.
The 2020 actuarial valuation of the TPS will commence this year. Although the results won’t be known for some time, further employer contribution increases could take effect from 2022 or 2023.
What are the implications for independent schools?
Financial constraints dictate that TPS exit is a serious consideration – the increased TPS cost can be materially unaffordable at a time when schools are currently considering other well-publicised future financial challenges such as the possible addition of VAT to school fees.
We are aware that over 100 independent schools have already left the TPS in the past 12 months, with at least another 100 of the remaining 1,000+ schools currently consulting or planning to consult with staff regarding pension provision for teaching staff.
Can schools just simply withdraw from the TPS?
Yes. Schools can withdraw all of their teaching staff without any penalty.
This is important as in other multi-employer schemes the exit penalty would effectively be the school’s share of the substantial deficit (£22bn) – which could be millions.
What options do schools have?
Many schools that have already left have replaced the TPS with a defined contribution (DC) scheme. There are very few risks associated with DC schemes for employers as no promises are made regarding the pension that will be payable at retirement.
The employer contribution is agreed from the outset and is generally fixed for the duration in order that employers can accurately budget for their staff pension costs.
Many schools that have already left have replaced the TPS with a defined contribution (DC) scheme
A further option that some schools are exploring currently is that of a ‘parallel scheme’ where either the TPS or a DC arrangement is chosen by the teacher at an individual level. Specifically:
● Staff may choose to remain in the TPS but with a reduced salary (a pay cut) designed to shoulder some of the additional TPS cost that is currently being borne by the employer.
● Staff may stay on current salary but move out of TPS to a DC scheme. The school will decide on the level of contributions and other benefits offered.
Crucially, for both of the above options, the total cost of the package offered in respect of option one and two has to be the same. It will be the choice of the employee which of the two packages they prefer.
The parallel scheme option is complex and requires much thought and consideration before being offered – it doesn’t protect a school particularly well against the future risks associated with the TPS and should employer contributions increase again as a result of the 2020 valuation then schools will need to think carefully about how they would deal with this situation.
A further pay cut is unlikely to be well received by staff.
But isn’t DC a very poor relation of DB anyway?
Not necessarily. For many schools, the employer contribution to a replacement DC scheme has been set at a similar level to that paid to the TPS previously – and compared to many private-sector DC arrangements these are hugely generous DC contributions.
The current automatic enrolment minimum contribution is a combined 8% from employer and employee, many teachers would be contributing 25%+ if they maintain the same level for their DC employee contributions as they did in the TPS.
For example, we have estimated that a teacher aged 30 today (earning £30,000 currently and with a combined employee and employer contribution rate of 25%) could potentially accrue a pension pot of over £640,000 at age 68 (figures are inflation adjusted – therefore quoted in today’s money) even with relatively modest investment returns.
This could provide a draw-down pension of £25,000 to £30,000 per annum based upon a life expectancy of around 90, which equates to over 20 years in retirement.