The value of pensions and investments can fall as well as rise, you may get back less than you invested.
Transferring out of a final salary scheme is unlikely to be in the best interests of most people.
A defined benefit pension – also known as a final salary pension – is a type of workplace pension that pays you a retirement income based on your salary and the accumulated years you’ve worked for the company, rather than the amount of money you’ve contributed into the pension.
At retirement you may have the option to exchange some of your annual pension for a tax free lump sum and reduced pension. In the event of your death, this type of scheme will normally pay a pension to a spouse or civil partner at a prescribed level, for the remainder of their lifetime.
All investment risk is carried by the scheme, who are also responsible for all decisions about the payment of benefits and protecting the interests of their members.
With a defined contribution pension you build up a pot of money that you can then use to provide an income in retirement, the level of income you receive will depend on the level of contributions made and investment returns.
However, the level of annual pension you could receive from a defined benefit pension is based on:
- How long you’ve worked for the company.
- The accrual rate: the proportion of your salary you’ll get as an annual retirement income.
- Your salary while working: sometimes your final salary, or sometimes an average of your salary over your career.
Your company is accountable for making sure there is sufficient assets in the plan to pay you when you retire. If your employer gets into financial difficulty and cannot adhere to its pension commitments, the Pension Protection Fund (PPF) may satisfy your pension income, but you may receive a lower amount than your employer agreed.
Defined Benefit Pensions are increasingly rare, but you may have one if you’ve worked for a large company or a public sector organisation.
Private sector defined benefit pensions (and some public sector defined benefit pensions) are funded, which means you can get a cash amount for your pension and transfer the cash amount to a personal Pension of your choice.
However, it is crucial to understand you will be giving up the valuable guarantees offered by the final salary pension scheme. Instead, your pension funds will be invested into a personal pension, and the value will ultimately dictate the level of income you may receive when drawing your pension which will not be guaranteed.
If you have a final salary pension that’s worth over £30,000, you have to receive advice from a financial adviser, who is qualified in this area, before a transfer can be permitted.
If you’re in an ‘unfunded’ public sector pension scheme (for example a civil service pension, an NHS pension or a teacher pension), you won’t be able to relocate your pension. That’s because this type of pension uses the employer’s current income to fund pension benefits, rather than setting assets aside.
Generally, your Defined Benefit pension pays you a retirement income, starting at a certain age (60 or 65, for example). Your pension income grows each year to take into account the increasing cost of living. When you die, a portion of your pension can usually pay out to your partner or dependants.
Under new pension legislation, you can take 25% of your pension as a tax-free lump sum when you reach 55 years of age. This is relatively straightforward if you have a personal pension, but when it comes to final salary pensions, it can be complex. Your final salary pension provider may reduce the retirement income you are due to receive based on how much you have taken from your pension as a lump sum, this is known as commutation.
Please note most final salary pension providers will charge you for drawing your pension before the normal retirement age and you financial adviser will be able to provide more information.
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