In order to monitor your pension scheme performance, there are several things you need to know about your scheme and the information provided annually by the scheme managers. This should show the latest Fund value, which is the total of all the contributions paid since the start plus the growth over this period, less any charges deducted.
The unit value maps out the growth of the scheme over this period and the ratio of this year over last year, expressed as a percentage is the growth for that year; if the unit value started at 1.00, then the current value is the growth since inception, e.g. at 2.00 the value has doubled.
The Fund value would have grown much faster than this, reflecting the number of contributions made; if this is after ten years then Fund value will equal 10 times the average contribution plus the growth over this period, at least 15 times, but higher due to compound growth over the ten years.
Compound growth is a complexity that can be more readily understood by considering the value doubling times for various growth rates. This can be applied to all forms of savings, including dormant pension schemes, mortgages etc. and the times are shown in the table below:-
Interest Rate / Growth % 2.5 3 4 5 6 7 8 9 18 27
Doubling time – years 28 23 18 14 12 10 9 8 4 2.4
So for a doubling time of 10 years the growth rate is 7% per year, or at a rate of 7% savings will double every ten years. The short rates occur with Bank and Credit Cards and need careful watching.
Another area is that of inflation over the 40 year pension saving period, by one of those mathematical quirks, at 2.5% the total growth or correction factor is 2.7, roughly and easily remembered as equal to the rate of 2.5%. At 3%, the average annual wage increase/ index, it is 3.2, say 3.
So after 40 years at 2.5% inflation, your pound is worth £1 divided by 2.5, = £0.40, i.e. 40np. If your wages increase steadily at 3% each year, then after 40 years it will be 3 times your start salary and stays ahead of inflation, therefore you can use today’ values to work in real terms.
To calculate the expected value and income for your final pension you can use the yield factors previously discussed (blogs 8 & 15), which are given again in the table below;-
No. of Years 10 20 30 40
Fund Yield Factor @4% 10.9 24 40 59
“ “ “ @t6% 12.1 29.8 55.6 93
“ “ “ @ 8% 13.4 37.2 79.3 153
Pension Yield Factor @4% 0.67 1.38 2.46 3.64
“ “ “ @6% 0.74 1.83 3.42 5.72
“ “ “ @8% 0.82 2.29 4.90 9.40
These are in real terms with inflation at 2.5%, wage rise at 3%, and payment/annuity at 6%. The factor multiplies the annual pension savings (including Employer) to give the fund value and pension income expected either in actual values or percentage of wage.
For example if you save £1,000 per year, after 10 years at 6% growth Fund would be £12,100 and pension income £740 pa and after 30 years £55,600 and £3,420 respectively. Pension savings of 8% at 6% growth, after 40 years would give a pension of 46% of wage in real terms.
These factors assume a steady increase in wage during the working life, if of course there is a sudden increase this has to be allowed for. Normally this occurs with a change of job or sudden promotion which may result in a change of pension scheme disrupting pension continuity.
If the pension can be transferred, the best option becoming increasingly available, then one needs to watch any charges that may arise and ensure they are kept low; this can often be negotiated, particularly with a new employer. Otherwise the old pension is sealed off growing annually by compound interest and the new pension starts building up again from year1. More next blog.
Savings Annuities Public Sector NHS Teachers Police Local Government Hutton State
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