This blog post is not intended and cannot be taken as financial advice. An individual should seek independent financial advice based on their own circumstances and objectives.
One of the concerns that faces the USS pension is the number of eligible members who have opted out of the scheme. As the contribution levels have grown (they are currently now the same as for the TPS pension that is common in post-92 institutions)* some people have felt the need to opt out and retain that 9.6% of salary, and perhaps make alternative pension plans. With the contribution level planned currently to go up to 11% in October, and with the unhelpful noises being made about potential further increases in the pipeline as a consequence of the 2020 valuation, it is understandable that some people might query the level of contribution in terms of how it impacts on their take-home pay each month.
In the 2020 Report and Accounts of the USS scheme, it was stated that 16% of eligible members had not joined or had opted out of the scheme. In 2015 that figure was 21%, with a dip to 12% in between. There were 147,137 active members of the scheme in 2015 and 204,753 in 2020.
Of course, from a collectivist point of view, there is a risk with people opting out, as that can put pressure on the pension fund to continue to maintain its commitments to pay out the pensions that have been accrued. The pension that you have earned to date is legally protected – you will get it as defined – but loss of income to the scheme puts some pressure on future pension commitments and contributes to that much critiqued deficit calculation (though of course it also removes liabilities from the picture).
From an individual point of view, this is really a conversation you need to have with your future self. There is one crucial issue to think about if you are considering opting out: for every £100 you contribute to the USS pension (before your salary is taxed), the employer contributes £200. If you opt out, you might get to keep that £100 (and get it taxed) but you are also losing that additional £200 of your salary that is being deferred to your retirement. To opt-out, then, is to turn down the additional 21.1% of salary (currently) every year of the employer’s contribution to your pension. It represents an immediate net-loss under the guise of a seeming immediate gain. If you find an alternative pension, you start with that £100 a month contribution (or rather £80, after it was taxed), instead of that £300. Assuming the reason you opted out was wanting to pay less to a pension, then it would be logical that you would in fact start again in a new pension paying in less than a third of what you were effectively doing in USS. This could have the obvious consequences of a.) very significantly shrinking the size of pension you and your family might later be able to rely on, and b.) increasing the age at which you might afford to retire. In coming to this decision, we would recommend that you seek independent financial advice that considers what age you would wish to retire and on what size pension. In recommending independent financial advice, we would note the scandal in recent years of people being advised to move out of Defined Benefit schemes and into Defined Contributions schemes, to their demonstrable loss but to fund managers’ gain.
The USS is still predominantly a Defined Benefit scheme, and the bulk or all of your pension is in an ‘Income Builder’, as USS call it: the more years that you contribute to the scheme, the higher the guaranteed income in retirement. That means that you can plan forward to retirement with some certainty of the kind of income you might get from day one, for the rest of your life. If you choose to find an alternative pension solution, not only will you be starting with a third of your USS contributions, but you will no doubt be using a defined contribution method – a form of pension that only lets you know with any certainty how much you are paying in, not at all what you might get in retirement: the more money you put in over time does not necessarily guarantee a larger pension.
Even if you only stay in a job for short time, you get to keep the pension you earn during that time forever, and it grows in value with each year to retirement. You can even hold multiple pension pots that you can draw on when you retire (or later consolidate them). Just a year or so of a Defined Benefit pension locked away when you are younger could be worth more than several years of Defined Contribution pension contributions later. Regardless of what changes are made to the pension scheme in the future, what you lock in now stays locked in on the current terms, and cannot legally be taken away from you or retrospectively downgraded.
The gender pay-gap and pension pay-gap is important here. Contribution levels are of course based on earnings, so the gender pay gap means that women tend to contribute less to their pension, and so have a lower pension in retirement. Women also tend to live longer, so having less to retire on is something that has an impact across a number of years. While a defined benefit scheme mirrors the pay gap in retirement, a defined contribution scheme is worse and amplifies that gap, due to the cumulative nature of investment growth – the size of the gap increases over time within the pension pot, assuming default investment choices.
The ill-health support and life cover that comes with contributing to a USS pension are also important factors to consider in any decision to opt-out of such ongoing benefits.
Of course, the recent behaviour of the USS in relation to valuations can be argued to be causing a kind of self-fulfilling prophecy. By constructing fictional deficits with ‘excessively prudent’ assumptions about the future growth of salaries, or of the scheme’s assets, they suggest that more is needed to pay in to the scheme, which puts off people, causes opt-outs, which then put real pressure on the scheme’s affordability if opt-outs reach a certain level. This is not in any stakeholder’s interest.
*(Note – the TPS has a tiered set of contribution rates. 9.6% is the most common rate paid in that scheme currently)