What is a Final Salary Pension Scheme?
Also known as a defined benefit pension scheme, a FSPS is one that promises to pay out a certain sum each year once you reach retirement age, with that amount usually being based upon the number of years you were an active member and your salary when you leave the scheme.
What are the benefits of a FSPS?
The pension benefit you accrue and receive is not linked to investment returns or annuity rates, and in many cases the pension scheme will often increase your pension income each year, in line with inflation or by a fixed amount.
Should you stay or should you go?
We are regularly asked some version of this question: “My employer has offered me a great incentive to transfer out of my scheme – what do I do?”
In the majority of cases, you are likely to be worse off if you transfer out of a Final Salary Pension Scheme, even if your employer is offering you an incentive to leave. This is because the guarantees offered by such schemes are extremely valuable, especially in this age of low investment returns, low gilt yields and longer life expectancy.
However, exactly because of these lower yields and longer life expectancy, this may not be the case for you. Some individuals find that transferring to a bespoke personal pension arrangement is more suitable for their individual situation.
The following case study shows how we helped one client make her decision and highlights some of the potential pitfalls you should be looking out for…
Client Case Study
Our client was offered a transfer value of £400,000 by her pension scheme trustees to transfer out of her Final Salary Pension Scheme
Because our client was single, with no one financially dependent upon her, we discovered during our review that were she to die before retirement, no benefits would be paid to her estate or her partner. Rather, the Pension Scheme would receive a windfall benefit to the value of £400,000.
Many Final Salary Pension Schemes will require members who are not married to prove financial dependency of any cohabiting partner and where financial dependency cannot be proved, no dependents benefits will be paid.
Moreover, if she were to die early in retirement, her pension income would have ceased, with no income being paid to her partner or her estate. Again, the pension scheme would be the benefactor.
In this situation, we agreed with our client to forego the valuable indexed pension being proposed in return for transferring to a personal arrangement.
Our client is happy that she is in control of her £400,000 fund, and has peace of mind that her partner and children will be looked after should she not live as long as we hope she will, with the added bonus that potentially the benefits they receive will be completely tax free.
Before making a decision, we need to review your current scheme in light of the changing landscape of pension regulation, your current family situation, health, financial goals and your plans for your retirement. The parameters are numerous, and we have seen after detailed analysis and discussions with clients that it is not always the best course of action to retain your Final Salary Pension Scheme. If it transpires that for your individual needs transferring out of your FSPS is the best solution, it would be advisable to act quickly, as transfer values, which have increased significantly in recent years, may start to fall as the economy enters a new period of growth.
How to decide if your Final Salary Pension Scheme needs to be reviewed
If any of the following apply to you, please do contact us to arrange a review of your current scheme and benefits:
- you have other significant pension assets
- your accrued pension is valued above £1.5 million (as this would be caught by a tax charge from April 2014)
- regular contributions made to your Final Salary Scheme are above the annual allowance limits (£50,000 for the 2013/2014 tax year and £40,000 for the 2014/2015 tax year)
- you want control over how your pension assets are invested and how and when the benefits can be paid
- you are single with no financial dependents, as we do not want the pension asset to be lost on death
- you are not confident that your former employer will keep funding the scheme
- you fear that your former employer may be in financial trouble, as this would lead to your final salary scheme benefit being transferred to the government’s pension protection fund which may not cover all of the benefit you have accrued
- you are in poor health with a reduced life expectancy.
Recently the budget announced some fairly radical changes to pensions which should be in place from April 2015, the main change is that an individual will potentially be allowed to take as much of their pension fund in one lumps sum, with the first 25% tax free and the remainder taxed at your highest marginal rate.
The government has already placed a restriction of the transfer of government sponsored final salary schemes, in that the members will not be allowed to transfer to an individual arrangement to tax advantage of the new proposed rules.
Some commentators in the financial press are suggesting that the government will move to stop any member of a final salary pension scheme transferring to take advantage of the proposed new rules
Therefore it may be advantageous to consider your options sooner rather than later.
What is the risk?
The advice to transfer a Final Salary Pension Scheme to a personal arrangement is very complex and requires detailed analysis and discussion. There are also associated risks to be considered when transferring from a FSPS to a personal pension arrangement, most notably that the pension income you get in retirement will depend on:
- the investments you choose and how well they grow;
- the charges taken out of the plan to pay for the administration and advice; and
- the amount of a retirement income your fund can buy at retirement.
During your review, your Cullen’s financial advisor will be able to discuss all the options available to you, as well as the potential risks of any course of action, before agreeing a proposal to best suit your individual needs.
What should I do next?
If any of the points above apply to you, or if you simply would like to understand a little more about your current scheme arrangements and benefits, please contact us to book your review.