Final Salary Pension Schemes

Also known as a "Defined Benefit Scheme" where your pension is based on the number of years you have worked for the employer and your final salary over the last few years before retirement, or on leaving the scheme indexed to your retirement.

It is the employer's responsibility to ensure there are enough funds within the scheme to provide this element of guarantee and will have to top up the fund if there is a shortfall.

Effectively, each member of the scheme accrues a percentage of their final salary for each year that they are an active member.

A Basic Example:

Date Joined Pension Scheme: 01/06/1985
Date Left Pension Scheme: 01/06/2000
Total Scheme Membership: 15 Years
Final Salary (earned in 2000): £20,000
Accrual Rate (sometimes shown as a %): 1/60th

To work out the basic scale pension divide the pensionable service (15 years) by the accrual rate (60ths) and then multiply it by the final salary (£20,000).

Its shown like this = 15/60 X £20,000 = £5,000 This amount increases in the period from leaving to retirement. What you contribute to a Final Salary Pension is irrelevant, what is important is the accrual rate, the higher the accrual rate the greater the pension at retirement.

Essentially, the pension scheme is promising that they will pay a retirement income, for the rest of your life, based upon on a percentage of your final salary. This style of pension scheme dictates the longer you work and the more you earn, the better the pension will be.

In past years a Final Salary Pension scheme was seen as a major benefit to an employee's remuneration however these days people tend to spend a lot less time in one job so a person may end up with several "preserved" or "frozen" final salary pensions.

As the cost of purchasing an income for someone retiring has increased dramatically and is expected to continue to increase, many employers are switching their pension schemes away from Final Salary Schemes to pensions without the perceived promise to avoid having to add more and more funds to ensure the promised income in retirement. For example, the estimated cost of purchasing a guaranteed income (an annuity) for someone who has already left the company may double by the time they reach retirement.

It is important to note that in transferring out of a Final Salary Pension Scheme the funds you transfer into could perform worse than expected and the benefits you receive could be less than that of the company scheme.