What is a final salary pension?

A final salary pension, also known as a defined benefits pension, is a type of workplace pension. However, instead of accumulating a pension pot, it provides you with a guaranteed annual income. The income depends on your final or average salary.

Although some private-sector employees still offer final salary pensions, they are most common in the public sector.

A final salary pension is typically more generous than other types of pensions. As such, give careful consideration before transferring to a different type of scheme.

How does a final salary pension work?

When becoming a member of a final salary pension scheme, your employer pays into a central fund on your behalf. The exception to this is where taxpayers directly fund the pension.

The scheme will have a normal retirement age. The pension is payable from that date.

A defined benefit pension is similar to a contract with your employer. The pension scheme they use agrees to pay you a fixed income from a fixed date. The income is typically linked to inflation and is payable for life.

With a final salary pension, you are aware of the income, as such, the schemes are also known as defined benefit pension schemes.

Income levels depend on several factors.

• Your pensionable service. This is the time you have been a member of the pension scheme.
• The scheme's accrual rate.
• Your final salary when you leave or your average salary during your employment.

 

What is an accrual rate?

The accrual rate is the rate at which benefits accumulate in the pension. The two most common rates are 1/60th and 1/80th.

For example, let us assume your scheme offers a 1/60th rate. Your income will be 1/60th of your final or average pensionable salary for each year of pensionable service.

As such, if your final salary is £60,000, and you have 10 years of pensionable service, your pension will be £1,000 multiplied by ten, giving you £10,000 per year. This income has a guarantee for life. Also, depending on the scheme, may increase each year.

Advantages of a final salary pension.

• Final salary pensions are typically more generous than DC schemes. A DC scheme would need to be above average in value to purchase an annuity equal to the income you will receive from a final salary pension scheme.
• The income from a final salary pension is a guarantee for life. This applies if the pension scheme remains funded.

 

Disadvantages of a final salary pension.

• Defined benefits pensions tend to be less flexible than DC schemes.
• Other than the tax-free lump sum, you cannot withdraw any further large lump sums. Also, you are unable to vary the income you receive from the scheme.
• A final salary pension scheme ends on your death.
• A widow's pension may be available if you die early. However, most of the benefits are not applicable. As such, your children may receive nothing.
• There is also a small risk that the pension scheme will collapse in the future if it is not adequately funded. An example of this would be if the employer goes bankrupt.

 

However, the Pension Protection Fund (PPF) safeguards defined benefits pension schemes. In most cases, your income would continue via the PPF. There may be limits on how much the PPF can guarantee.

Can you transfer a final salary pension?

You can transfer a DB pension to a defined contribution scheme. This is a defined benefit or final salary pension transfer.

Your pension provider will offer you an amount of money to relinquish your guaranteed pension for life. This is not payable as a cash payment but as the cash equivalent transfer value.

You can then invest the sum into a defined contribution pension scheme. As such, you will be able to access this pot from the age of fifty-five. However, it is increasing to fifty-seven.

You cannot transfer all final salary pensions. If already drawing a pension from a final salary scheme, you will not be able to switch it to a DC scheme.

Furthermore, public sector schemes are supported directly by the taxpayer and can only be transferred to another final salary scheme.

Your cash equivalent transfer value will depend on economic factors and individual factors such as your age and health.

How to calculate your CETV

Different providers use different methods to calculate CETV. However, a typical method is to multiply your projected final salary pension by twenty. As such, if you are aged fifty-five with a projected pension of £10,000 at age 65, your CETV would be £200,000.

When considering a transfer, you need to consider how long your pension pot will last if you transfer to a defined contribution scheme. A financial advisor can help you with these calculations, thus helping you to achieve the best possible retirement, but also ensuring your money lasts as long as possible.

Advantages and disadvantages of transferring a final salary pension scheme

Advantages:

• Access to your pension at an earlier age.
• Income levels can vary.
• If the funds perform well, your pension will grow in value.
• Any unspent funds can be left to your heirs.

 

Disadvantages:

• Your pension income may be lower because DB schemes are typically more generous.
• If you live to an old age, your pension funds may run out.
• Your pot is vulnerable to stock market falls and may decrease in value.
• If you do transfer, you will be responsible for managing your pension.
• You may need financial advice for which there will be a charge.

 

How does a transfer work?

Every case is different, but transferring a final salary pension can take some time. Furthermore, if your transfer value is £30,000 or more, it is UK law that you take financial advice before a transfer can be made.

Not only do you need to consider the advantages and disadvantages, but if you do transfer your pension, you will need a suitable investment strategy.

Do I need financial advice to transfer my final salary pension?

As previously mentioned, it is UK law to seek advice if your defined benefit pension is valued at £30,000 or more.

Furthermore, some providers insist you obtain advice even if your pension value is below £30,000.

Having money now is always appealing, particularly if there is an urgent matter to deal with. A financial advisor can help you identify your short- and long-term needs, so you are in the best position to make an informed decision. They may also show you the benefits of your pension, which you have not considered before.

Summary

Deciding whether to transfer your final salary pension is a complex decision. You must consider the advantages and disadvantages before making such a significant decision.

Although a transfer can offer you greater flexibility and growth potential, it also involves risks. Also, you will be giving up a guaranteed lifetime income.

It is vital to seek financial advice. A financial advisor can help you make the best decision for your personal circumstances and long-term retirement goals and needs. They will cover all your options and help you make the best decision. Also, remember that what works for someone else might not work for you.

A financial advisor can be a valuable long-term asset, helping you save or make money over time. However, finding a suitable financial advisor can be time-consuming. This is where Regulated Advice can help. We work with more than 250 advisors covering every city in the UK. As such, we always aim to find an advisor who is close to you, reducing the stress associated with the process. So, if you are looking for a financial advisor, it could not be easier than using Regulated Advice.