Final Salary Schemes for Occupational Pensions

Also known as Defined-Benefit (DB) Schemes or Superannuation Schemes, Final Salary Schemes provide a pension based on your salary (known as final pensionable salary) and the number of years you have been in the scheme (known as pensionable service). The scheme is run by trustees who look after scheme members' interests and you usually pay contributions into the scheme in addition to those of your employer. Your employer is responsible for ensuring there is enough money at the time you retire to pay you the pension.

How Much Will You Get?

Your final pensionable salary may be based on your earnings when you retire or leave the scheme, or it may be based on your average earnings during the time you contributed to the scheme (typically over the last 3 years before retirement). In some schemes, additional payments such as bonuses and overtime are also included in this figure, whilst in others, only your basic salary counts towards your pension.

With this type scheme, your pension will be a set percentage of your final pensionable salary, known as the accrual rate. The most common accrual rates are 1/60th or 1/80th of your pensionable earnings for each year of pensionable service.

For example, Jane has been a member of her employer's scheme for 20 years and her final pensionable salary is £33,000 a year, with an accrual rate of 1/60. Her pension benefit is therefore calculated as follows:

Other Features of Final Salary Schemes

In addition to providing members with a pension at retirement, some final salary schemes provide additional features, such as:

• life assurance cover
• the option to exchange some pension for a tax-free cash sum
• ill-health early retirement
• survivor's and children's pensions after the member's death
• the option to pay additional voluntary contributions (AVCs) to buy additional benefits

In the UK an estimated 8.5 million people have a final salary pension scheme.

Benefits and Risks of Final Salary Schemes

Benefits

• Your pension entitlement is not dependent on the performance of the stock market or other investments.
• Your employer will make pension contributions on your behalf.
• Your pension benefits are linked to your salary whilst you are working, so they increase automatically as your pay rises.
• The pension scheme will normally increase your pension income each year in line with the Retail Prices Index (RPI) or a set percentage, whichever is the lower.

Risks

If your employer becomes insolvent, then there may not be enough money in the pension scheme to pay the pensions to its current and former employees. However, in April 2005, the government set up a Pension Protection Fund to protect members of salary-related schemes. This fund pays some compensation to scheme members whose employer has become insolvent, although the level of compensation may not be the full amount.

What Happens If You Change Jobs?

If you leave the company, you will stop paying into the pension, and provided you have been in the scheme for 2 years or more, then the benefits in the scheme can be left as a deferred (or preserved) pension. Alternatively, the pension could be transferred into another scheme, although there are risks and costs associated to that process. It is always a good idea to take financial advice before considering transferring a pension.