Final Salary Schemes

Defined Benefit Schemes are otherwise known as a Final Salary Scheme or a Salary Related Scheme.

They are known as defined benefits schemes because you receive a specified pension benefit at retirement.

You are guaranteed a certain level of pension when you retire, as well as other benefits.  These are worked out according to a formula set out in the scheme rules.  In a final salary scheme the formula works as follows:

Working out your retirement benefits

For every year that you were building up benefits in the scheme, you get a certain proportion of the salary you were earning at the time you left the scheme.  This proportion will vary depending on the scheme that you are a member of.

For example, it may be a 1/60th scheme, a 1/80th scheme or indeed any other fraction such as a 1/100th or 1/45th scheme.

Example Pension Calculation For a 1/60th scheme:

If you had been a member of a 1/60th pension scheme for 20 years the pension that you would receive at retirement may be as follows:

1/60th scheme - 1/60th of your salary for each year that you have been a member of the scheme.  1/60th X 20 = 20/60th 's = 1/3rd of your salary as a pension.  This may reduce should you have the option, which is normally the case, to take an element of your pension as tax free cash.

Example Tax Free Cash Calculation

This works in a similar way to the pension calculation although the formula may be different e.g.  3n/80th 's for each year that you have been a member of the pension scheme - where "n" is the number of years that you have been a member of your pension scheme.   

Following the example from the above:

The maximum tax free cash that could be taken at retirement would be: 3n/80th s = 3 X n (e.g.  if n = 20 years service)/80 = 60/80 = 3/4 of salary as tax free cash with a reduced pension. 

Care should be taken when working out your retirement benefits - because there may be slightly different rules that apply to you, there may be early retirement penalties, there may be other benefits that attach to your pension scheme such as life assurance cover or spouses benefits should you die.

Maximum Retirement Benefits

These are subject to Inland revenue limits and a brief explanation of these is detailed in the Occupational Schemes Rules pages.

We recommend that you seek professional help when looking at Final Salary Scheme retirement benefits.  Contact us today for help.  Contracting out via a Final Salary Scheme will provide you with a pension benefit called a Guaranteed Minimum Pension (GMP).  This means that part of your pension is guaranteed to at least provide the same benefits as SERPS would have provided.  GMP’s can be housed in either a Final Salary (Defined Benefit) scheme or a Section 32 Buy Out Plan.  Retirement benefits that have accrued must be treated in a certain way from when you leave a scheme to your Normal Retirement Date, as follows:

For people who leave on or after 1st January 1986, any pension benefits accrued from 1st January 1985 over and above the GMP (GMP is explained in the section for SERPS and Contracting Out ) has to be increased at the lesser of 5% or the increase in the Retail Prices Index until retirement.  For leavers on or after 1st January 1991, all pension benefits in excess of the GMP have to be increased until retirement at the lesser of 5% or the increase in the Retail Prices Index until retirement.  It is important to note that some schemes allow for higher increases than this.

Once your pension starts to be paid, any benefits that you earned since 6th April 1997 have to increase at 5% a year or the increase in the Retail Prices Index, if less.  This is known as Limited Price Indexation.  It is possible for pensions that you have built up to benefit from any future surplus which arises under the former employer’s scheme.  Any investment risk is taken on by the employer.  This is because, if the investments do not perform well enough the employer will have to top up the scheme.  i.e.  Your employer has effectively guaranteed your retirements and therefore will still have to purchase them even if investment conditions have not been favourable.  Care should be taken though from an employers point of view as the Government have introduced new Stakeholder Pensions Laws which may affect any occupational pension schemes ran for employees.