Final Salary Pension Scheme Explained

What is a Final Salary Pension Scheme?

A final salary pension scheme, often called a defined benefit (DB) scheme, is a type of occupational pension plan. It promises to pay a retirement income based on a member’s salary at or near retirement and their length of service with the employer.

Key Concepts

• Pensionable Salary: Typically the average salary over the last few years of employment or the salary at retirement.
• Accrual Rate: The fraction of salary earned each year towards the pension (e.g., 1/60th).
• Guaranteed Income: Provides a predictable, lifelong income stream.

How it Works

The pension is calculated using a formula, commonly: Pensionable Salary × Accrual Rate × Years of Service. For example, a salary of £40,000, an accrual rate of 1/60, and 30 years of service would yield an annual pension of £20,000 (40000 * 1/60 * 30).

Advantages

These schemes offer significant security to employees, as the employer bears the investment risk. They provide a reliable income, often linked to inflation, ensuring purchasing power is maintained.

Challenges and Misconceptions

Many such schemes have closed to new members due to rising costs and liabilities for employers. A common misconception is that they are the same as defined contribution schemes, which is incorrect.

FAQs

Q: Are final salary pensions still common?A: They are increasingly rare, especially in the private sector, due to financial risks for employers.

Q: Who manages the investment risk?A: The employer or pension fund manages the investment risk, not the employee.