The Ultimate Guide to

Final Salary Pensions

Introduction

If you have a defined benefit or final salary pension, you will likely have read about the relatively high transfer values that are currently being offered to some people. While the numbers may appear tempting, is the final salary pension right for you and how can you find out?

At Pensionhelp, we always give impartial and professional advice to people looking at their retirement options. However you decide to manage your money, it is important you are able to weigh up the costs and the benefits of every possible scenario before you act so you can make an informed decision.

In this guide, we will present you with the reasons for and against final salary pension transfer; how the CETV (cash equivalent transfer value) is calculated; how your yearly income is calculated; and how to make a successful transfer should you decide that this is the best option for you.

Deciding what to do with your pension is not a choice that should be made lightly, and this guide is just that - a guide. The information we are providing should help to educate you about your options so when you do go to speak to a pension advisor, you already have an idea of what you need to ask them about your own pension.

We have included an income calculator and infographics to help explain all the different aspects as clearly as possible.

If you have any further questions or would like to seek advice from a professional pension advisor, get in touch with us today.

Final Salary Pension

What is a Final Salary Pension?

A final salary pension provides a retirement income for life which is based on your salary and service period. The final salary pension scheme is also known as a defined benefit pension scheme.

Final salary pensions are largely being phased out in favour of defined contribution pensions. This is because the final salary pension is an expensive option for companies, especially in an ageing society where people are living longer.

In a defined contribution pension, your pension income is dependent upon the fund value that you have managed to save, you make the investment decisions and take the investment risk. In a final salary pension, your income is calculated according to your pensionable earnings and the number of years that you have been a member of the scheme. Your employer / former employer carries the investment risk.

How Does Your Final Salary Pension Work?

Contributions are paid into the scheme by both employer and employees. All contributions effectively go into a pot with other members of the same scheme. You do not have your own individual fund value as you would in a defined contribution scheme. This ‘pot’ is invested on your behalf by the trustees of the scheme.

While you have no control over your funds or where they are invested, you are protected from falls in the stock markets because your company must make up any shortfall. This is because the company takes all the investment risk.

Pension Income

Working Out Your Pension Income

With a final salary pension you are provided with a pension that pays you a certain income each month. With a final salary scheme, this is usually a proportion of the salary you earned in your last year, or years working for your company.

To calculate your yearly income with a final salary pension scheme, you need to know your pensionable earnings, the number of years you have been in the scheme and your accrual rate.

The total amount of your pension is calculated as the number of years that you have been a member of the scheme divided by the accrual rate and then multiplied by your pensionable earnings.

This can be written like this:

Number of years in the scheme

Accrual rate (usually 60 or 80)

X Pensionable earnings

So if you are in a pension scheme for 40 years and your pensionable income is £45,000 with an accrual rate of 1/60, then your yearly pension income would be £30,000.

40

60

X 45,000

Accrual Rate

The accrual rate is the proportion of your pensionable earnings that you get for each year you are a member of the scheme.

Accrual rates are usually expressed as fractions and the most common are 1/60 and 1/80.

You can use this calculator to work out your own yearly pension income. Just enter the correct information and press enter.

Number of years in the scheme

Accrual rate (usually 60 or 80)

X Pensionable earnings

Please note that if you retire before the scheme's normal retirement age, early retirement reduction factors are likely to be applied to your pension.

Income Calculator

Please provide the following details to closest of your knowledge:

÷
x

Your yearly pension result:

Transferring Your Pension

Who Can Transfer a Final Salary Pension?

You have a legal right to receive a Cash Equivalent Transfer Value if you are a deferred member of a scheme. You do not necessarily have a right in the year before the scheme Normal Retirement Age (NRA), although some schemes will provide one to members in this position.

Members of unfunded Public Sector Defined Benefit Schemes are unable to transfer to a Personal Pension.

These include:

  • Teachers superannuation
  • The NHS scheme
  • Police
  • Military service schemes

If you have a final salary pension then you can seek out advice on whether the final salary option is available to you.

Why Should You Consider the Transfer Option?

For the vast majority of these scheme members, the final salary pension is the most suitable option. However, as transfer offers are at relatively high points, the transfer option has become more relevant for individuals to consider.

The scheme pension is not suitable for everyone and it is worth reviewing your transfer value alongside your aims and circumstances to see if it is a suitable option for you.

CETVs are Relatively High

There are a range of variables which affect your transfer value (a cash equivalent transfer value or CETV) including assumed inflation, gilt yields and assumed investment returns. This means that the transfer value of your pension fluctuates regularly and may rise or fall, sometimes these changes can be dramatic.

At the moment, the value of many final salary pensions is high (compared with previous years transfer values) because there has been a fall in gilt yields. When gilt yields and corporate bond yields fall, the cost of converting capital into income increases and transfer values rise.

After the Brexit vote in June, gilt yields fell to record lows. As a consequence CETVs increased.

Why You Should Consider the Transfer

Who Should Consider the Transfer Option?

There are many reasons to consider the transfer option. While transferring may not be for you, knowing your options is always the best way to make an informed decision.

Please note if any of these scenarios are relevant to you, this does not necessarily make transfer suitable. It may however be worth reviewing your scheme benefits to see if they are appropriate to your circumstances.

You Have No Spouse / Partner

If you are single, then it could be worth considering the transfer option. One of the benefits of a final salary pension is that a dependant’s pension is payable. If you have no qualifying partner, you will receive no benefit from the survivor’s pension. You may be able to secure a higher pension in your own name, or consider an option where the death benefits are brought in line with your requirements such as to pass on to your children.

You Are in Poor Health

If you are in poor health that reduces your life expectancy, then a review of your transfer value is appropriate. The transfer value is based on you living in line with average life expectancy and you may be able to achieve a higher pension that takes account of your illness. If you have a very short life expectancy, you may want the option to spend your transfer value over a short period of time, or pass the full fund to family members.

If you are not in good health at the time of the transfer and should die within the 2 years following the transfer, it is possible that a value could be allocated to the pension plan for inheritance tax purposes and included in your estate.

You Would Like Increased Flexibility

With a transfer, you have more flexibility with what you can do with your pension. You can take flexible income, take higher income in some years and reduce it in others. If the structure of the scheme income payment does not suit you, then exploring the transfer option may benefit you. An example of this would be if you want higher income in the early years of retirement with a view to reducing this later in life such as when your state pension starts.

You Want to be More Tax Efficient

On transfer you can control the timing and amount of your income. You may benefit from this if you wish to avoid paying higher rate tax for example. If you wish to have control of your income, it may be suitable to review your circumstances.

Your Company is in Poor Financial Health

If your employer / former employer suffers an insolvency event, your pension could be reduced. This could be considerable if you have a significant pension as a cap applies. If you are concerned about the long term future of the scheme sponsor, you may benefit from a review of your final salary pension.

Why You Should Consider Staying In

Why Should You Consider Staying in the Final Salary Scheme?

The final salary pension is suitable for the vast majority of scheme members. It will pay you an index linked income (usually) throughout retirement where you are not responsible for the investment risk.

The sections below provide more detail about why you should stay in a Final Salary Pension Scheme.

You May not be Able to Afford Your Bills

A final salary pension will pay you an income until you die. If you take the transfer option, you take on the investment risk. If things don’t work out as expected, you may not be able to afford to maintain your lifestyle and you will have very little capacity to repair this situation.

You Have No Other Assets

For most pensioners, their pension is their main source of a secure income and funds their basic needs. If you do not have any other assets that could provide this income, then transferring your pension is a risky move. This is because if your investments go wrong for any reason, you would have nothing left to fall back on.

If You Are Married

One of the benefits of a final salary scheme is that it will typically continue to pay a proportion of your pension to your spouse / qualifying partner after you have passed away. If you have been the main earner in your family, this is particularly valuable to those you leave behind.

If the Transfer Value Offered is Low

Throughout this document we have referred to transfer values being relatively high. Many transfer values represent a good deal on a pure mathematical basis, but you need to check your own transfer value, as on review, it may not represent good value for you.

Transferring a Final Salary Pension is Irreversible

If you decide to transfer your pension then it is very unlikely that you will be able to transfer back into the final salary scheme. This decision is usually irreversible.

Commutation Factors

In some schemes you can give up (or commute) part of your pension for a tax free Pension Commencement Lump Sum (PCLS) The Commutation Factor is the rate that you convert this pension. For example, with a scheme that has a commutation factor of 20, each £1 of pension you give up, will provide you with a Lump Sum of £20.

The higher the commutation factor, the greater the lump sum you will receive. Commutation factors typically reduce with age.

Commutation Factors

In some schemes you can give up (or commute) part of your pension for a tax free Pension Commencement Lump Sum (PCLS) The Commutation Factor is the rate that you convert this pension. For example, with a scheme that has a commutation factor of 20, each £1 of pension you give up, will provide you with a Lump Sum of £20.

The higher the commutation factor, the greater the lump sum you will receive. Commutation factors typically reduce with age.

How To Transfer

How to Transfer a Final Salary Pension

In order to take the first step in making a successful transfer, you need to know what your CETV value is. Once you know what your CETV is, you can start to assess whether the transfer option is suitable for you on a mathematical basis. You can start to compare your current scheme benefits with the alternatives available.

If you have a transfer offer of over £30,000 (in total), it is now a requirement to have been advised by a qualified and regulated Financial Adviser. Regardless of the value of your transfer, we would always suggest you seek independent, professional advice to be sure that you are making the right decision for you.

An Adviser will gather information regarding your scheme and more importantly about your circumstances and priorities. This will include details on your health, your assets, your income and your outgoings. They will also discuss the ‘shape’ of pre-retirement that you are looking for, the sort of risks that you are prepared to take and what you want to happen when you die.

Once they have this information, they will provide you with a written report detailing their advice. They will discuss this with you and providing you are in agreement with them, they will assist you in executing the advice they provide. This may be to take no action, take a pension from the scheme or to transfer your pension.

At Pensionhelp, one of our advisers will be happy to discuss your situation with you and may be able to address any queries you have about your pension.

Ongoing Advice if You Transfer

If you do transfer from a Final Salary Pension scheme, you will carry the investment risk. Your financial adviser will be able to offer you ongoing investment advice and advice on making withdrawals. This will take account of your tax position and the Lifetime Allowance if applicable.

Timeline Of Transfer

The Transfer Time Scale

The final salary pension can take up to 9 months to complete. Legally, your pension provider has 3 months to give you a CETV (cash equivalent transfer value) for your final salary pension. You then have 3 months to make a decision about the right option for you, whether to stay in the final salary pension, or to transfer.

GATHER INFORMATION

During your initial phone call consultation, we will determine your financial circumstances and future requirements

Step 01

RESEARCH & RECOMMEND

We will research the most suitable financial solutions based upon your individual needs. We will provide you with a report explaining your options and explain the associated implementation costs. We will discuss our fees and the options for paying them at this stage. You will not incur any fees without agreeing them in writing, and they can often be paid via a charge on your policy if this is your preference.

Step 02

IMPLEMENT

We will then implement your recommendations. This is also subject to your approval.

Step 03

ONGOING ADVICE

We will then ask if you require ongoing financial advice, and will explain the services we offer.

Step 04

Please Note

The value of investments can fall as well as rise. You may not get back what you invest.