This article was last updated on 1 March 2021.
The value of your final salary pension is an important factor in planning for life in retirement. It can allow you to prepare a budget and better manage your finances, making retirement less stressful in the process.
This article will aim to provide a comprehensive overview of final salary pensions, answering the following questions in the process:
Your final salary pension, which can also be known as your defined benefit pension (db pension) is a guaranteed form of income for life after retirement.
The actual value of your final salary pension is dependent on several factors; including a percentage of your final salary, how many years you have been a part of the pension scheme and an accrual rate.
DB pensions differ from defined contribution pension schemes wherein your final income is dependent on contributions plus the performance of any investments you may have made.
Your final salary pension scheme will provide you with pension benefits depending on several factors, including your earnings and duration as a member of the scheme. However, the rules vary between different schemes, so it is important that you check the terms of your specific scheme for your own circumstance.
The benefits that are provided to you at retirement may be either an income or a tax-free cash lump sum with an income alongside that.
Should you become seriously ill which leads to an early retirement or ill-health retirement, you may be eligible to draw your pension benefits earlier than usual. However, the amount that you may be entitled to receive could be lower than the amount you would otherwise receive if you carried on working until the normal retirement age.
If you have to retire early due to ill-health, it is worth checking with a financial advisor or the pension scheme administrator about the benefits you may be entitled to receive.
This video might also be useful to understand how a final salary scheme works.
Currently, some members of a final salary pension scheme are being offered transfer values in order to encourage them to leave their schemes. This gives members the chance to transfer out of their final salary pension scheme in to usually some sort of defined contribution arrangement, such as a Self-Invested Personal Pension (SIPP)..
The payment from the scheme is known as the cash equivalent transfer value (CETV), which you would receive in exchange for transferring out of your defined benefit pension scheme.
The amount that you are able to take out as a lump sum and the consequences this will have on any payments you are due to receive in the future is known as a commutation factor. This commutation factor advises how much income you will lose if you do indeed withdraw a lump sum from your final salary pension.
Your commutation factor is calculated using your actuarial assumptions and states how much you are entitled to withdraw from your pension after taking your lump sum.
You have to take your lifetime allowance into consideration when withdrawing from your pension. If the cumulative value of any income taken from your pension fund exceeds your lifetime allowance then you are liable to incur an income tax on the excess withdrawn.
If you do want to access your final salary pension at an earlier-than-normal age, you can transfer to a defined contribution pension scheme. Although this may provide you with some more flexibility, there are risks involved, such as poor investment performance reducing the income you eventually receive.
This is in comparison to a final salary pension transfer, which not only provides a guaranteed income at retirement age, but this income is stabilised in line with inflation and other fluctuations, unlike the less reliable defined contribution scheme.
In the current environment, final salary pensions are considered by many employers to to be generous, making them an expensive scheme to offer, particularly as people are living longer. As a result, employers are seeking to remove any pension liability from their accounts.
One way to do this is by offering a relatively large pension transfer value, to convince members to swap out their final salary pension for a defined contribution pension. By doing so, the final salary pension becomes less of an annual income and more like a quantifiable cash lump sum, under the guise of a CETV.
This CETV will be calculated as a multiple of the annual benefit that you are entitled to receive from your scheme. However, the size of this multiple is dependent on factors such as age, how long you have to retirement and when you left the scheme.
If you wish to find out the value of a cash equivalent transfer value, you can do so by requesting a valuation from your defined benefit pension scheme. By doing so, you can find out how much your scheme is willing to offer you in the event that you decide you wish to leave the scheme.
Although you can ask your pension provider for a valuation of your cash equivalent transfer, you can also roughly work out the value of your final salary pension using an online calculator.
By doing so, you can calculate the value of your CETV in comparison to other transfer offers available on the market. This can ensure that you are likely to receive the best valuation for you.
The internet has many free final salary pension transfer calculators although you need to ve VERY careful about doing these as they are highly unlikely to accurately calculate the value of your final salary benefit. Your pension scheme administrator and scheme actuary are the only people that can give you an accurate figure.
If you are seeking advice about your final salary pension and the option of taking a lump sum, then you can contact a professional via the UK Care Guide about any questions you may have.
We work with with BP Sanders to help bring you independent advice on your pension options. Through a free consultation they can help you decide what is the right option for you.
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Or you can call BP Sanders directly on 0333 567 1603