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A final salary – or defined benefit – pension scheme is one that pays out a set annual income in retirement that is based on the number of years service and an agreed proportion of someone’s salary.
As salaries tend to rise with experience – which are reflected in the pensions - these schemes can be seen to provide quite generous pension income in retirement, allowing people to continue to live to a similar standard as when they were working.
Many public sector workers have final salary pension schemes and these schemes have for a long time been considered a valuable benefit. Some large, private employers also offer them, although far fewer than before.
Many employers are now offering employees a different kind of pension – “defined contribution”. These do not promise a certain level of income in retirement; instead, they promise a percentage of your salary that will be paid in to your pension pot by your employer, to which the employee may also be able to make additional payments. The amount you will receive from your pension will depend on how much the amount contributed over your working life has grown over time – which is used to provide income in retirement.
Because defined contribution pensions are dependent on investment returns and the level of contribution, rather than final salary, this type of pension tends to result in comparatively lower income in retirement than defined benefit schemes and you could end up with less than predicted if your funds value fails to grow.
However, remaining in a “DB” scheme means that you cannot take advantage of the new pension freedoms, which entitle you to take out the whole of your pension fund as a lump sum if you wish. Some employers are offering “cash equivalent” sums to DB employees to encourage them to consider switching to defined contribution. These lump sums can seem very tempting and are particularly high at the moment, because interest rates and bond yields are relatively low.
Consequently, some people with valuable defined benefit pensions are transferring out, often against the advice of an adviser, in order to benefit from access to their cash. It may also have benefits on death as the funds can be passed on. The Financial Conduct Authority has warned that fewer than half the transfer cases it has reviewed are suitable for transfer to a “DC” scheme.
And funds not held in FSCS protected products or within FSCS limits may not be fully protected in the event of the failure of the provider. You can find out more information about FSCS pension protection here.
Another reason some people have been considering transferring out of defined benefit schemes is concern about what would happen to their pension fund if their employer collapsed. Workers in the BHS pension scheme were a recent, high profile case. The Pension Protection Fund covers employees for losses up to 90 per cent of their pension, up to £34,655 a year.
Anyone with a pension pot worth more than £30,000 has to receive financial advice before they can transfer out of a defined benefit scheme. You will have to pay an adviser for this –. Research from Momentum, a pension provider, has shown an increase in the number of employees going against the advice of their adviser to stay in a defined benefit scheme.
Transferring between pension schemes can be fiendishly complicated. Pension schemes benefits may also vary and schemes are fairly unique, and so while a transfer might suit one person in one scheme, it doesn’t mean it will be right for another. Personal circumstances, as well as pension terms and conditions, will all make a difference to what’s best.
Always carefully consider all your options before making any decision because your pension is there to provide for your future. If you do transfer, check that you will be FSCS protected. FSCS does not only protect deposits but investments and insurance policies too.
For further information and resources, visit:
- The Government’s Pension Wise service
- The Pension Advisory Service
- The Money Advice Service for more information, useful tools and calculators.