If you have a Final Salary pension, retirement planning can seem more straightforward. However, you will still have to make important decisions and so it’s crucial that you understand the income it will provide.
Whether retirement is just around the corner or some years away, reviewing your pension arrangements can give you confidence in your financial future.
What is a Final Salary pension?
Final Salary pensions, also known as Defined Benefit pensions, are often referred to as ‘gold-plated’. This is because your income in retirement is defined and protected, and the benefits are typically competitive when compared to alternative types of scheme.
The main alternative to a Final Salary pension is a Defined Contribution scheme. Here, employees and employers make contributions, which benefit from tax relief, and these contributions are invested. At retirement, pension savers have a lump sum based on how much they’ve contributed and investment performance. At retirement, they will have to decide how to access the pension to best ensure it lasts for the rest of their life.
In contrast, under a Final Salary pension scheme, your future pension income is defined from the outset. This income is usually linked to how many years you’ve been a member of the scheme and either your final or average salary. At retirement, a Final Salary pension will pay out a regular income for the rest of your life.
Among the benefits of a Final Salary pension are:
- You don’t take responsibility for investments: You don’t need to decide where to place your pension contributions, as this is done by the pension scheme trustees. The performance of investments won’t affect your retirement income.
- It provides an income for life: Life expectancy can make planning for retirement challenging, as you don’t know how long your pension savings need to last for. With a Final Salary pension, your income is guaranteed for life. This removes this element of uncertainty.
- The income is usually linked to inflation: In addition to a lifelong income, Final Salary pensions are usually inflation-linked. This means your income will rise in line with the cost of living, preserving your spending power in real terms.
- Many Final Salary pensions come with additional benefits: Your Final Salary pension may offer auxiliary benefits that provide peace of mind, such as a pension for your spouse, civil partner or children if something were to happen to you.
As a result, Final Salary pensions can be incredibly valuable for providing certainty and security in retirement.
Calculating your retirement income
The good news is that understanding the income you can expect to receive from your Final Salary pension scheme when you retire is usually quite straightforward.
How the income delivered from a Final Salary pension is calculated varies from scheme to scheme, but is always defined. If you can’t find the paperwork detailing how your income is determined, contact your pension scheme.
There will typically be three factors used to define your Final Salary income:
- How long you’ve been a member of the scheme
- Your final salary, your average salary over the last three/five years of employment, or a career average
- The accrual rate. This is the fraction of your salary that is multiplied by the years you’ve been a member of the scheme.
Let’s say you earned £80,000 at retirement and it was your final salary that was taken into consideration. You paid into the pension scheme at your company for 40 years and the accrual rate was 1/60. Your income in retirement would be £53,333 annually using the formula below.
Years as a pension scheme member (40) x accrual rate (1/60) x salary (£80,000)
You should receive an annual statement from your pension scheme, which ought to include a value of your pension at retirement.
Creating flexibility with a Final Salary pension
A Final Salary pension can provide you with a secure income throughout your retirement. Yet, you may still want a flexible income to meet your retirement goals.
This may be because you plan to spend more in early retirement, or at a later point. For example, you may have mortgage debt remaining, plan to travel, or want to financially support loved ones.
There are ways that you can achieve the best of both worlds.
Many Final Salary pension schemes will allow you to take a one-off lump sum from your pension to kick-start your retirement. This will reduce your income during retirement but does provide the flexibility of a capital sum if you need it.
Other options include:
- Using a Defined Contribution pension (if you have one) to fund a one-off expense
- Using your other assets, such as investments, to create a flexible income
It can be difficult to understand how your different assets fit together and how you can use them to reach retirement goals. This is an area we can help you with.
Transferring out of a Final Salary pension
If you have a Final Salary pension, you may be considering transferring out. This is often called a ‘Defined Benefit (or DB) transfer’.
At retirement, you do have the option of giving up the benefits of a Final Salary pension and, instead, receiving a lump sum which must be transferred to a Defined Contribution pension. There may be some benefits to doing this, such as providing greater income flexibility, but for most people transferring out isn’t the most appropriate option for them.
Receiving a lump sum can seem attractive. However, a guaranteed income for life is often more valuable. It’s important to weigh up your financial security and retirement goals before making a decision. If your Final Salary pension is worth more than £30,000, you must take regulated financial advice first.
Please contact us to discuss your Final Salary pension and what it means for your retirement lifestyle. Usually, there are ways to create a flexible income stream that will suit your goals whilst retaining the security offered by your Final Salary scheme. Please get in touch or call (01372) 724 249.
Please note
Transferring out of a Defined Benefit pension is not in the interest of the majority of people.
A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits.
The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
