What is a final salary pension?

I’ve heard about final salary pensions and they seem to be the best pensions on the market. Could you explain what this type of pension is for me please? And how do I go about getting a final salary pension?

Question asked by Ms A Gibbs
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Answered by Michael Englefield

  

Final salary pensions explained

It’s fairly simple to explain final salary pensions: They essentially do just what it says on the tin. They’ll pay you a pension based on your final salary at retirement.

What is a defined benefit pension?

The bad news is that final salary pensions are workplace pensions set up by your employer; you won’t be able to get one of these by yourself. If your employer doesn’t offer a final salary pension, then you won’t be able to get one anywhere else.

At retirement, the fund then promises to pay the employee a guaranteed income for the rest of their life, which is almost always index-linked to keep pace with inflation.

Final salary pensions are sometimes known as defined benefit pensions, although in reality they’re just a type of defined benefit pension, which fall into two broad categories:

  • final salary pension is a pension where your post-retirement benefit based on your salary at retirement
  • career average pension is a pension where the post-retirement benefit is based on the average of your salary across your career with that employer.
 

How are defined benefit pensions calculated?

The income you’ll get from a defined benefit pension is based on three factors:

  • number of years you’ve been with that employer and contributing to the DB scheme
  • your pensionable earnings (for final salary schemes, this is your salary at retirement; for career average schemes, this is your mean salary across your career)
  • your pension scheme’s accrual rate (the proportion of your earnings you’ll receive for each year spent in the scheme, usually represented as a fraction, e.g. 1/80th).

The common calculations for working out how much your final salary pension is worth are:

Defined Benefit Scheme Calculation

Number of years in scheme

30 years

Pensionable Earnings

£50,000 final salary

Scheme accrual rate

1/80th

30 years * £50,000 * 1/80th
An annual income of £18,750

 

Are final salary pensions disappearing?

Final salary schemes or career average pension plans used to be far more common, but today they’re only really provided by the largest employers or the public sector.

This is because of the expense of maintaining DB pension schemes at a time when investment performance has not always kept pace with the forces of inflation and increasing longevity.

As a result, a number of defined benefit pension schemes are now closed to new members, with employers who previously offered such plans now offering defined contribution plans instead.

 

Can I leave my final salary pension scheme?

You don’t have to stay in your pension scheme. You do have the option to transfer out of your final salary scheme. Given final salary pensions are an expensive long-term promise, many pension funds are offering attractive cash equivalent transfer values to encourage members to leave the scheme in exchange for a pot of cash.

To discover more on what today’s high CETVs mean for your final salary pension, click here. Alternatively, if you’re interested in working out how much you might receive if you left your final salary pension scheme, Drewberry’s Final Salary Pension Transfer Calculator could be of interest.

Note that a final salary pension transfer is not right for everyone and you will be giving up considerable benefits by undertaking a transfer.

Pension
 
Final salary pension
 
Defined benefit pension
 
This information does not constitute financial or other professional advice. You should consult your professional adviser or contact us directly on 02084327333 should you require financial advice. It is important to ensure any insurance policy you take out is suitable for your needs.
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