Defined benefit pensions. OK, so most of them are now career average. But which career average? Nominal or real wage?
To illustrate. Assume inflation is 100% per decade and happens once a decade. Just to assume something. Also, no real pay rises, no promotions – because I just want a model that only looks at inflation.
Nominal wage Real wage today
1980s 2,000 16,000
1990s 4,000 16,000
2000s 8,000 16,000
2010s 16,000 16,000
OK, if it’s career average real wage in values of date of retirement then that pension is based upon a 16,000 annual salary. 70% of 16k or whatever. But if it’s of nominal wages it’s 30k/4 = 70% of 7.5k.
Which is a substantially lower sum. I cannot believe that the unsions would allow that second calculation. Therefore I asume it’s some variant of the first. But what is that calculation? How are past nominal wages upgraded to present values before the pension is calculated?
Anyone?
It’s neither. Deferred annnuities are inflated by whatever is in the pension scheme trust deeds and what the trustees have determined.
Commonly CPI with caps and floors (which makes hedging exposure a pain but that’s another story)
And it’s not the wage that’s inflated, it’s the pension itself. Mathematically there is no difference but that’s what is accounted for.
And that’s why the triple lock is so interesting…. Highest of uncapped inflation, average wage growth or x%.
Oh and for the geeks there are civil service pensions in private schemes due to privatisation of services. These are inflated by whatever is determined by the Secretary of State by regulation. Literally no formal legal linkage at all that we’ve found.
All of this is U.S., and I’ve been out of the game for over a decade, but:
Career average pay pension plans generally are based on nominal wages (I’ve never seen/heard of anything else).
Social Security does index earnings based on averages, so a $16k salary from 20 years ago is upgraded to $64k (rough estimate).
Most union pension plans aren’t pay-based, they are years of service * a dollar amount. For example, $40 per year of service, so after 25 years you’d get $1,000 per month. The dollar amounts are renegotiated regularly, usually being retroactive.
For NHS pensions (the one I know about) we get 1/54 of our salary each year as pension. It is then re-valued by “Treasury Order+1.5%” each year, as long as you are a member of the pension scheme. If you leave the scheme but don’t retire you lose the revaluation going forwards, but can regain it if you rejoin within 5 years.
https://www.nhsbsa.nhs.uk/sites/default/files/2024-05/2015%20Members%20Guide%20%28V13%29%2005.2024.pdf
Here in the US, the current federal civil service pension is based on the average of your highest three years of earnings. The amount is 1% per year of service. Adjustments for inflation are CPI-1% if inflation is over 2%, otherwise nothing. This is accompanied by a 401k defined contribution plan with the government matching the first 5% contributed, capped at 10% of wages. This plan can either be Roth IRA where taxes are paid on contributions and growth is untaxed, or standard IRA where contributions are untaxed and taxes are paid on withdrawal, with mandatory withdrawals starting at age 73. This plan was put in place by Ronald Reagan to reduce the pension costs for government workers.
What Gasman said. You generally accrue an amount of pension based on the rules, determined by your salary at that time.
So if your pay in year 1 is 2000 and your accrual is 1/43 (what I got when I was briefly in the civil service) then you’d accrue £46.51 annual pension for that year. Each year this is uprated (again depending on the rules – I think mine was just flat RPI).
So if year 2 is 4000 and inflation was 75% then you’d accrue £93.02 for year 2, and this would be added to the (46.51 * 1.75) from year 1 – giving a new total of £174.41. This is the notional annual pension at your retirement age. If you retire early, it’s reduced (again by an amount determined in the rules) and if you retire late it continues to increase until you take it (often by a higher amount – rules again).
Most DB schemes for private sector are CARE schemes, the R being crucial here as it means revalued, so effectively based in real earnings, not nominal earnings. Some of these schemes revalue above inflation.
What this actually means is that, with a higher accrual rate, and where benefits are revalued at above inflation (but member’s contributions are paid on actual salary and the public sector keeps telling us their salaries have lost value in real terms) the cost of these pensions is actually higher than the final salary schemes they replaced for many individuals.
You won’t hear the Unions tell you that though, all the talk is of how the pension isn’t s good as it used to be as it’s now based on average earnings. Lying c*nts the lot of them.