Final Salary Pension Closure
Final Salary Pensions – When your pension scheme is closed
This document has been prepared specifically for those whose Final Salary Pension scheme has been or is about to be closed by their employers. It is intended to help you understand the changes and the main options that will now be available to you.
Your pension is a Defined Benefit (DB) scheme, more widely known as a 'Final Salary' Pension. This type of pension is often described as 'gold plated' because it promises to pay a guaranteed and generous income when you retire for as long as you live. The pension income you receive will be based on your ‘final’ or ‘career average’ salary when you leave the pension scheme.
The current Final Salary Pension scheme will offer you:
- A generous specified level of pension income payable at a specified date in the future, normally the scheme retirement age.
- The option to give up some of the pension in return for a tax free lump sum and a reduced pension income.
- The option to take the pension earlier than the normal retirement age with a reduction applied for each year it is taken before the normal retirement age.
- Once in payment, the pension income is indexed i.e. it increases each year by a measure of inflation and is payable for the remainder of your lifetime.
WHAT DOES IT MEAN WHEN A SCHEME IS CLOSING?
If your pension scheme is fully closed, the pension you have built up will be ‘frozen’ at the date of closure. The frozen pension is the amount of pension income you have built up at the date the scheme was closed and the pension scheme should provide you with a statement that shows how much your pension is worth. This is reported as your ‘deferred’ pension at the ‘date of leaving’ because you will have left the scheme and the pension is deferred for payment until your normal retirement age.
IS MY PENSION SAFE?
All pension benefits built up in the Final Salary scheme are safe - as long as the Company keeps the pension scheme funded sufficiently.
Your frozen pension will remain yours and preserved to draw when you decide to draw it. Between the date of the scheme closing and your normal retirement date, your frozen pension will be indexed which means, as prices rise with inflation, your frozen pension will maintain its value. For example, if your frozen pension is worth £10,000 per annum in 2017 and inflation is 2% over the next twelve months, the value of your pension would be increased to £10,200.
WHAT HAPPENS NEXT?
Your employers will have set up a replacement Pension scheme called a Money Purchase Scheme but this is likely to be referred to by the general term ‘Group Personal Pension Plan’ (GPP). This type of pension scheme is very different to the final salary scheme and essentially will cost the Company less to fund for you on an ongoing basis.
WHAT IS A MONEY PURCHASE SCHEME?
Going forward you will be put into the new company Money Purchase scheme (the GPP). The Company will pay contributions into the GPP and you will top up these contributions with your own contributions. Your personal and the Company’s contributions will be set as a percentage of your salary.
Unlike the Final Salary Scheme, there is no promise of a guaranteed pension income when you retire. Instead the contributions from you and the Company will be invested in the stock market and build up an amount of money for you to draw upon when you retire.
The income you receive from a money purchase pension scheme is dependent upon the value of your pension plan. In simple terms, a money purchase pension is like having a savings account: you can spend as much as you wish but there is the risk you run out of money. Alternatively you are able to exchange the value of your pension plan with an insurance company in return for a guaranteed income.
The earliest time you can draw the pension will be age 55 and you are able to draw 25% of the pension fund as a tax free lump sum. The balance of the pension fund is taxed as income if and when you draw the money out.
You should know that, whilst your Final Salary Pension and the new GPP are funded by the same Company (your employers) the pension schemes are entirely separate and ring-fenced from each other.
YOU HAVE OPTIONS
If your Final Salary Pension scheme is closing fully it is important that you understand how you are affected and what your options are.
Under current legislation the Company has an obligation to offer you a transfer value unless you’re within one year of the scheme normal retirement date. This is a cash lump sum the pension scheme has to offer so you can consider whether it is worthwhile retaining your promised pension or taking the lump sum.
It is important to request this value not only because the Company do not automatically provide you with a true guaranteed figure but also because you want to be in an informed position. The transfer value statement should be accompanied with a statement that shows how much your pension benefits have been frozen at.
Ultimately, the decision on whether to accept a transfer value is a complex one but our message is to make sure you put yourself in the most informed position; know where you stand and have your transfer value calculated, particularly if your Final Salary scheme is facing closure.
Upon receiving the calculation it is likely that a significant sum of money will be offered to give up your benefits in the scheme. We can help you understand what the offer is, explain your options and which option is the most suitable for your personal circumstances.
Please feel free to contact me or any of my colleagues at Suttons IFA if you would like a chat to help you request a transfer figure.
Written by Ben Preston APFS, CertPFS(DM), CertCII (MP) Chartered Financial Planner of Suttons IFA
Ben is a Chartered Financial Planner Occupational Transfer Specialist. He holds the CII AF4 Advanced Pension qualification required to be able to advise individuals on whether they should retain their Final Salary pension benefits or accept a cash equivalent transfer value and transfer out of the pension scheme.