28th September 2023
general
If you do have access to a final salary pension, or another type of defined benefit scheme, read on to find out more about how the scheme works and your options.
Building Up Benefits
In a defined benefit scheme, the amount of pension you build up is dependant on two things – your years of service and your salary at retirement. For example, you may earn 1/60th of your salary in pension benefits for each year you work for your employer.
A true final salary scheme will calculate this based on your earnings when you retire. A career average scheme works in a similar way, but calculates benefits based on your earnings in each year of employment, increased with inflation. A final salary pension will most benefit employees who receive substantial pay-rises during their later years of employment.
Your scheme may allow you to make additional voluntary contributions (AVCs). This can mean buying more pension, adding extra years of service, or building up a flexible ‘money purchase’ pot that you can access as you wish.
It is unlikely that you will have the option to join a new final salary pension, although you may have benefits in an existing scheme. Some organisations, including many public sector employers, still offer career average schemes for new joiners.
Your Options at Retirement
You can start to take your benefits from the scheme’s normal retirement age, which could range from 60 – 68. Some schemes offer the option to take your benefits earlier, although this will usually result in a reduced income. Deferring your benefits until later will normally increase the amount payable.
Most of your pension will be paid in the form of an annual pension. This is guaranteed for life and will normally include some form of inflation-linking. There are specific rules for this depending on when you joined your scheme – it’s worth asking your scheme administrator for full details. Some schemes allow you to waive annual increases in exchange for a higher starting pension. Your pension income will be taxed at your marginal rate.
You may also be able to take some of your pension as a tax-free lump sum. This could be paid on a standalone basis, or in exchange for giving up some of your annual pension. Your lump sum must be taken at the same time as your pension.
What Happens if You Die?
Most defined benefit schemes will pay out an annual spouse’s pension, for example, 50% of the pension that you would have received. Children’s pensions may also be included. Dependant’s pensions are paid at the scheme trustees’ discretion and may be stopped, for example, if your spouse remarries.
It’s worth checking if the scheme rules allow for unmarried partners to benefit from your pension as this is not always the case.
Dependant’s pensions may be payable if you die either before or after retirement. Some schemes will also pay out a lump sum if you die while you are still working.
Is the Scheme Secure?
Your defined benefit pension is not subject to investment risk in the same way as a money purchase pension. If the markets fall, the scheme still needs to pay the same amount in pension income.
Many schemes are operating at a shortfall, which means that the amount of assets they hold is not enough to fully cover their obligations. The trustees include certain assumptions in their calculations, including an estimate of investment growth and how many members are likely to die before taking benefits.
If the scheme cannot cover its responsibilities, the employer may need to pay more in to address the shortfall. If this becomes unaffordable, they might need to close the scheme to new members.
If the employer becomes insolvent, the scheme could be taken over by the Pension Protection Fund. This ensures that members will still receive a pension, although in some cases, benefits may be capped.
Can You Move Your Final Salary Pension?
If you move employers, it might be possible to transfer your benefits to another defined benefit scheme. While your new scheme must offer you an equal benefit value to your existing employer, there is no guarantee that your eventual pension will be the same – this is because schemes use different assumptions to calculate benefits.
Some employers, including the Civil Service and Teachers’ Scheme, are members of the Public Sector Transfer Club. This ensures consistency in how valuations are calculated, and makes it easier for members to move their benefits.
You can move your final salary pension to a personal pension scheme if you wish. You will need to take financial advice if the value is over £30,000, and in most cases, moving is discouraged. It’s highly unlikely that the benefits offered by your scheme can be matched through a personal pension, and you take on the added investment risk.
Other Options to Meet Your Retirement Goals
Final salary (or defined benefit) pensions offer significant benefits and guarantees, but they do not suit every scenario. Many members cite a lack of flexibility over retirement income or death benefits as a reason to consider transferring out.
However, it might be worth thinking about how you can use your defined benefit pension combined with other options to meet your retirement goals. For example:
Please don’t hesitate to contact a member of the team to find out more about your retirement options.
