Final Salary or Defined Benefit Pension Schemes
Defined Benefit or final salary pension schemes have traditionally been considered the gold standard in pension funding.
Providing benefits based on a combination of how long you have worked for your employer and how much you earned, they offer guarantees over what you can expect in retirement in a way that is not possible for the now more common individual and workplace defined contribution plans.
If you are a member of a Defined Benefit (DB) scheme, you accumulate retirement benefits based on a combination of:
- Your earnings (measured either as your final salary or perhaps an average of your salary over a specified period)
- Your length of service
- The 'accrual rate' that applies to your scheme, most commonly 1/80th or 1/60th
To calculate what you will be due you will therefore multiply your (final or average) earnings by length of service and then divide that number by the accrual rate.
If your qualifying earnings were £36,000 and you had worked for an employer with a 1/60ths scheme for 10 years, your retirement income would be:
(£36,000 x 10 years) /60
Making your expected retirement income £6,000 a year.
Benefits of defined benefit schemes
The one, major plus that these DB schemes offer you is their guarantee. You are told what benefit you can expect and it is then up to the employer, the trustees and their designated investment manager to make sure the scheme can afford to pay you. They take on all the risks. All you have to do is work and wait until the agreed retirement date for that money to be paid.
And if you are wondering about the news stories concerning deficits, bankrupt employers and mismanagement, all is not as bad as that can make things seem. Regulations now exist that make it almost impossible for a scheme to forgo its responsibility to its members. And in the unlikely circumstances that a scheme does run out of money, the Pension Protection Fund is there to bail out the scheme and pick up most of the guarantees promised*.
The option to transfer
If your DB pension is classed as a 'funded scheme', and you have not yet started taking your retirement income, you do have the option to request a transfer to a personal pension. This will offer you more flexibility over taking the benefits and decide for yourself how much income you take in any one year, rather than having someone else decide that for you.
However, in taking your money out in this way, you are giving up valuable guarantees. If you take control of the money, you also take on all of the risk. And you may find yourself worse off as a result.
For this reason, considering a transfer from a DB scheme should always be done in consultation with an expert. In fact, the Government considers financial advice so valuable that if your DB benefits are over £30,000, they insist that you speak to a regulated financial adviser. You would not be able to go ahead with a transfer without doing so.
Note: if your DB scheme is classed as unfunded - which includes a lot of the public sector schemes - you will not be able to transfer your benefits to a private pension. You may, however, still be able to transfer to another (unfunded) DB scheme.
* In the event of a pension fund entering the Pension Protection Fund, different levels of guarantee apply depending on whether you are already receiving your pension, are still making contributions or have left the employer and become a 'deferred' member. You can find more information on the Pension Protection fund website (opens in a new window). Or speak to one of our financial advisers here at A&J Wealth.