Final salary schemes are a type of defined benefit pension scheme that are offered by employers.
The term final salary may not be wholly accurate in relation to many schemes and many should be referred to more broadly as defined benefit.
Typically a defined benefit scheme provides a pension benefit payable at retirement, based on your earnings and your length of membership in the scheme.
Historical many schemes operated on an accrual basis of 1/60 of salary for each year of service with the employer, although some had lessor accrual rates such as 1/80 of salary for each year of service, and a small number better accrual rates such as 1/45.
For a typical 1/60 scheme, an example of potential benefits for a member who had 30 years service, and a salary of £30,000 would be 1/60 x 30 x £30,000 = £15,000 pension.
It’s important to note that ‘final salary’ doesn’t necessarily mean the actual salary that the member was earning at retirement or leaving the employer. There can be many definitions of “final pensionable pay”. Some schemes will base this on basic pay in the last year, some will average this over a number of years, some will be based on total earnings. Each scheme can be different.
All schemes will have a normal retirement date, typically 60 or 65.
Whilst the minimum retirement age is now age 55, there are some limited circumstances when scheme members can still access benefits from age 50 If the scheme rules meet very specific requirements. Equally, many schemes can offer early access in the case of ill health for example where it can be proven that a member is no longer able to work due to their health.
In most schemes, if a member wishes to take their pension before the normal retirement date, there will be a penalty or reduction in the amount of pension payable.
There are some schemes which equally do not permit access earlier than normal retirement date.
Where members left a scheme prior to retirement date and they have an amount of pension benefits accrued to that date. Whilst many people refer to these as frozen pensions, a more accurate description is deferred. In the vast majority of schemes for members who left employment and membership of a scheme after 1990, there are legal requirements for the scheme to increase the value of benefits each year broadly in line with inflation.
In terms of accessing the pension at normal retirement date or from age 55, most schemes will offer the option to commute part of the pension for a tax-free lump sum. This does mean that the amount of pension is reduced in order to access the lump sum.
The amount of lump sum available will vary from scheme to scheme and may have restrictions if the pension scheme was contracted out of the state earnings-related pension scheme or state second pension between 1978 to 2016.
Whilst the pension is payable for life of the member, most schemes also provide for spouses or dependants pensions. Again these vary from scheme. Typically a spouse’s pension can be 50% of the member’s pension, but can vary up to 67% or can be less than 50%/
For members with no spouse or dependants, there may be guaranteed periods for payment of the member’s pension or a return of contributions in some cases
As defined benefit schemes by their very nature offer a fixed or defined amount of pension, the member has an entitlement to that pension and does not have a fund value attributed to them under the scheme.
However, most schemes with the exception if unfunded public sector schemes such as NHS and Civil Service will offer members a transfer value if they have not already taken benefits under the scheme.
Transfers values are a capital sum that can be paid to an alternative pension, which extinguishes any rights under the defined benefit scheme.
Transfer values vary dramatically from scheme to scheme and are dependant on a number of factors as well as the actual benefits payable under the member’s scheme.