The curse of the defined benefit pension

Trapped in the world of pensions

I went to a very interesting finance seminar today. I work in public sector finance and the seminar was focused on defined benefit pensions the public sector and I tell you…the discussion left me perplexed.

For those that are not aware, a defined benefit (DB) pension is a workplace pension very common in the public sector (and historically available at large private sector companies but less-so now) where your employer guarantees you a pension income in retirement based on a predetermined calculation. Most schemes, mine included, also include life insurance as part of the deal. Here is an example (and this is a completely made-up scheme but loosely based on my current scheme):

  • You contribute 8% of your gross salary to the scheme
  • Your employer contributes 10% of your gross salary to the scheme
  • You work for 20 years under these conditions
  • Your accrual rate is 1/60th
  • Your gross salary at retirement is £60,000
  • In this example, you would be guaranteed to receive an annual pension at retirement of 20 years x 1/60th x £60,000 = £20,000, which is usually linked to inflation.
The typical reaction to pension calculations

So on the surface, this seems like a great deal right? As an employee you have a guaranteed income in retirement linked to inflation. You will have a stress-free retirement in exchange for a long and successful career in the public sector. Simple.

But here is the thing which became clear to me as I listened to the seminar: in a defined benefit pension scheme you will contribute an amount from your salary during your employment which has absolutely no direct link to the pension income you will receive. This is risky and means you have little control over when and how you you receive your pension.

Furthermore, in the current economic environment, the total contributions made into DB schemes are normally not enough to fund the scheme. With interest rates low and people living longer, the schemes are becoming riskier and the deficits higher. Eventually, the scheme trustees will have to either: (1) reduce pension benefits; (2) take on more risk; (3) require higher contributions into the scheme; or (4) CLOSE THE SCHEME. The problem is employers can’t increase their contributions infinitely and employees will start opting out of the scheme if employee contributions are too high. Employers then have to plug their pension deficits even more. It is a vicious downward spiral and the reason many private defined benefit pension schemes have closed.

Personally as an employee in the public sector, now that I have contributed to the scheme for a few years, I feel a bit stuck. I can obtain a valuation of my pension and transfer it to a personal plan, but then would lose out on the guaranteed pension in the future and the life insurance benefit I am currently receiving. In fact, the UK Money Advice Service states:

“Any potential advantages of transferring from a defined benefit pension scheme to a defined contribution one are often outweighed by the costs, risks and loss of benefits involved”

I am also worried about the possibility that the pension I think I am going to get when I retire is actually nowhere near the pension I will actually get because it simply isn’t affordable.

As I walked back to my car from the seminar, I reflected on my journey to financial independence and my hopes to retire earlier than the standard pension age. A specific part of the presentation stuck with me. The presenter spoke about the lack of freedom that one has in a defined benefit scheme.  He had a slide which depicted the three typical phases of retirement:

  • The first phase is the ‘ACTIVE PHASE’ –> this is the phase in retirement where the retiree is still active, traveling the world, visiting friends and family.  Spend in this phase is high.
  • The second phase is the ‘WIND-DOWN PHASE’ –> in this phase the retiree is less active and takes fewer trips as mobility starts to decrease. The retiree is still relatively healthy but less able to travel and therefore spend is modest.
  • The third and final phase is the ‘CARE PHASE’ –> this is where the retiree is elderly and requires increasing amounts of care, possibly in a care home. Mobility is close to zero and spend is very high (but likely funded through assets).

Looking at these phases, clearly retirees will want income to be geared towards the start of their retirement. This is when retirees will have high expenses that they do not want to fund through assets. However, inflation-linked defined benefit pension schemes provide the majority of their value towards the back-end of retirement. Only around a third of the value is realised in the first 10 years. And if I want to retire at say, 50 or 55, then my ACTIVE PHASE will be even longer than most. So does this mean my ‘gold-plated’ defined benefit pension scheme is less valuable then I thought? Perhaps.

Above all, the thing I have taken away from today’s presentation is the realisation that I must continue on my journey towards financial independence and debt reduction on my own terms. This does not mean I am considering withdrawing from my workplace pension scheme. To replicate in a personal pension the pension I would get through my workplace scheme I would have to invest around 40 to 45% of my gross salary (rather than the 8% I currently contribute) and even then it wouldn’t be guaranteed!  So I will continue contributing, but when running early retirement forecasts, I will reduce any dependence on workplace pensions and focus on robust post-tax investments to fund the majority of our early retirement years.

Visiting New York

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Brooklyn Bridge Park

I have today just returned from a quick and tiring but fulfilling trip to New York. I know New York well. My father is from New York and I lived there for two years after university. A lot of my friends and family are there, so it was a mainly a trip back to see them and to bring my son for the first time.

We had a 5 day trip planned to fit in with my son’s half-term break from school. We were flying with British Airways and as luck would have it, right before we were about to board our flight, global BA IT systems crashed and all flights were cancelled. The 5 hour period in Heathrow after the cancellations were announced were absolute chaos (think crying children, 4-hour long queues, missing BA staff and low food supplies). We had to drive 2 hours back home without our bags.  We ended up purchasing another flight the next day online (which we are claiming back from BA), but it meant our trip was cut short by a day. Four days in NYC jet-lagged, on a budget, wanting to visit people and see attractions is just crazy, I would not recommend it.   On top of that we didn’t receive our baggage until day 3 of the trip so we had to spend most of the first day buying toiletries and clothes. Thank goodness BA have confirmed they will reimburse expenses and pay compensation. I have already put my claim in but we are currently out of pocket by just shy of £4,000 until the reimbursement is paid!

Once we finally got to New York, we were lucky to stay in a large 2-bedroom Airbnb apartment in Brooklyn, two blocks from my old apartment and steps away from the subway. It was the perfect base from which to explore the city. We did mainly free activities where we could meet friends and family and see the sites without having to pay extortionate entrance fees. New York does not have free museums like London or Washington DC, so you have to seek out free attractions.  Here are some of the free things we did over the three days:

  • We went to The High Line. I had never been here and this place blew my mind. It’s an elevated, disused railway-line in Manhattan that has been turned into a free public park. The planting is beautiful.  There are views of the Hudson river to the west and the park snakes through the neighborhoods of Chelsea and the Meatpacking District. I recommend going early on a weekday as there are narrow sections that can get quite crowded. We went at 9.30am on a Tuesday and it was perfect.
  • We walked from The High Line to the Flatiron building and then to Union Square and around the streets of Greenwich Village. Meandering around Greenwich Village is one of my favourite things to do.
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The High Line, New York City
  • We went to Cortlandt St Stration on the R line and walked around Westfield at the World Trade Center and viewed the 9/11 memorial. The Westfield building is incredible to see, it reminded me of a rib-cage.  The space is very calm and peaceful even when packed with people.
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Westfield, World Trade Center
  • We went to Grand Central Station and stood in the lobby for a good 15 minutes, then walked to Bryant Park and the New York Public Library. From there we walked to Times Square, walking in and out of the shops.  Then we walked to Central Park, found some green space and relaxed.

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Times Square
  • We visited Brooklyn Bridge Park and the Brooklyn Heights Promenade. This is a great part of Brooklyn and offers amazing views of the lower Manhattan skyline.
  • We walked around the Brooklyn neighborhood of Park Slope for hours and hours. There are tons of little shops, cafes, music venues, and beautiful quintessential Brooklyn brownstones.

 

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Brooklyn Bridge Park

This is not to say that I did not have moments of weakness. I am prone to frugal failures, after all. I spent $100 just on myself to eat out with old friends. We were in a restaurant for 6 hours eating and drinking and talking and the restaurant was expensive (but delicious!). I also bought my son a couple toys and I purchased some cheesy souvenirs.

Overall though, assuming we get the money back from BA (we better!), we have spent much less than our budget of £1,000 spending money for the week. The £1,000 was put aside for budgeting purposes but I wanted us to spend significantly under this – and we did! I am still reviewing spreadsheets to work out exactly how much we spent that won’t be reimbursed, but I’m thinking it is closer to £500 including my lavish dinner out.

There are lots more free things to do in New York that we did not get time to do and I want to give a big THANK YOU to the great tips I received from other bloggers. If anyone else knows of other free attractions in New York that I did not mention above, I would love to hear about them in the comments.

On the costs of conceiving a family

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I have to let you into a secret that not many people know about me…

I am infertile.

Those three words are severe and harrowing for me to write down. In fact, I spend a fair amount of energy keeping my infertility hidden from nearly everyone. But it is the truth. And in an attempt to overcome this infertility, my husband and I have spent a stupid amount of money on medical bills over the past 9 years.

The brief backstory

After 4 years of marriage, my husband and I were having no luck in the baby-making department, so went to see our GP. Luckily we live in a part of the UK where the National Health Service (NHS) will fund fertility treatments if neither partner has another child. After 3 years and 13 free treatments, we had a successful IVF cycle and ended up with our loving, magnificent, cheeky 4-year old son, born in 2012.

Once he was around 2 years old we felt the strong urge to provide him with a sibling but we were no longer eligible for state funding so we decided to self-fund one more round of IVF.  We took out a £5,000 personal loan, went through the pain and stress of the cycle, and had nothing to show for it.  At this point, my husband and I were cognisant of our debt and knew that logically we should stop and enjoy our perfect family of 3. But when it came to family and emotions and thoughts of what ‘should be’, logic got clouded. At our follow up appointment at the fertility clinic, we were passed a leaflet.  In large letters next to a staged photo of a smiling chubby baby (of course!) was: “IVF plan with a money back guarantee. Finance available”.

In a what feels like a blink, and clearly under the haze of fuzzy logic, we signed up to a 3-cycle money-back guarantee plan. We paid £12,000 cash upfront for it and if after 3 cycles we do not have a baby, we will get 70% of this cost refunded.

Where we are now

We have now completed 2 out of our 3 cycles. We were nearly successful in the last cycle, but it ended in a miscarriage at 6 weeks. We are due to have our final treatment next month and today we went to the pharmacy to spend the usual £400+ on the first tranche of drugs.

I am ready for this to be over. I am ready to come to terms with our family size, whatever it may be and to stop fretting over what-ifs and uncertainties and possibilities. I am ready to focus on my family for what it is right now and to be grateful for it in its entirety.

The cost of creating our family has been financial and emotional. We are paying off a debt for a child we never had. With our new focus on financial freedom and simple living (and in the clarity of hindsight) it becomes obvious to me: society’s message that one child is not enough has led me to this point.  Society is wrong.  My son is definitely enough.

As we approach this last cycle I have had time to reflect on our journey to get here. If I had known then what I know now, things might have gone differently. During my soul-searching I have written a list of things I wish I realised before going into infertility debt.

Five things I wish I realised before going into infertility debt:

  1. The infertility industry is a business that profits on couples during a time of desperation. If you have failed in a previous cycle, they will try and sell add-on treatments, most of which have no empirical evidence to prove they will increase your chance of conception. But of course, the fact that an additional option is out there leaves you thinking: “maybe I just need that one extra thing and it will work”.
  2. Only children are completely and utterly fine and well-balanced and lovely. Research has backed this up. There is no requirement for a sibling and the bond between a parent and an only-child can be so strong and so beautiful.
  3. Having more than one child does not guarantee they will be friends as adults. I hear many people say that they want their children “to be there for each other once they are gone” or to “share the burden” of caring for them in old age. My husband and I are planning our financial independence now so that our child does not have to care for us in old age. Hundreds of thousands of people enter old age without any children and rely on alternative care without a problem. I have also come to realise, based on recent experience, that in many cases there is one adult sibling who ends up doing the vast majority of care for old-aged parents. This is a sweeping generalisation but I have seen it happen in my family a few times now.
  4. Some people know how many kids they want (if any) but some people will never know; it is okay to not know. I have a friend who has 3 children and feels a great deal of sorrow for the 4th child she wants but her husband doesn’t. I also have a friend who absolutely knows that 1 child is all she wants and is content to stop. If I were to have a 2nd child there will not necessarily be an internal switch that says ‘enough’. I could have a sibling for my son and still feel unfulfilled. My life is as full and satisfying as I make it.
  5. Going into debt for a child that does not exist yet is all too easy to do. Companies exist solely to finance fertility treatments and are charging up to 15% interest for loans to fund treatments. Their websites are polished and professional and filled with beautiful babies, but remember these are profitable businesses. Getting sucked into these deals during a time of desperation is hard to resist.

If we are successful in our upcoming cycle we will rejoice I am sure. If we are not we will look forward to a special, fulfilling life as a family of 3. All family sizes, from a single person on their own to a large family, are wonderful in their own way.

Importantly, whatever happens next month, we will not abandon our financial plans to pay off ALL our debt in 10 years. Paying off our debt is a gift to our future family, whatever size it may be, and we deserve it.