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Company pension - salary related
Sometimes referred to as a final salary scheme or defined benefit pension scheme, this type of pension gives a pension promise. For each year that you are a member of the pension scheme, the scheme adds a proportion of your salary to the ‘promise’.
Schemes vary considerably, but as an example a scheme may give 1/60th of earnings for each year’s membership. So after 20 years you would have earned a ‘promise’ of 20/60ths, or 1/3rd, of your salary as a pension payable from the normal retirement age of the scheme. Another scheme may build your benefits at 1/80th per year, or some other fraction.
The benefit is not always worked on your full salary. It may be worked just on your basic salary (excluding any overtime or bonuses), and sometimes a deduction is made to allow for the state pension that you may receive.
At retirement some schemes give a cash lump sum as well, tax free. Other schemes will usually allow you take cash in exchange for a reduced pension.
This type of pension scheme usually provides for widow’s and dependants’ pensions (in case you die), and sometimes early retirement on enhanced terms in the event of ill health. Once the pension income starts to be paid it increases each year.
Part of your pension may replace part of the earnings related top-up to your State pension.
You will usually have to make a contribution towards the cost of the scheme.
How safe is this type of scheme?
The ‘promise’ is just that – it is not a guarantee. The pension scheme will pay your pension in full provided it has the funds to do so when you retire. The scheme gets its funding from the employer, so there is an indirect link to the financial stability of the employer.
If a pension scheme is unable to pay all of its obligations, there is a protection scheme that aims to help. You should note that this scheme does not provide 100% protection of all of the benefits that you had been led to expect. Further detail can be found at www.pensionprotectionfund.org.uk
These types of scheme are becoming a rarity for new employees, as the cost to the employer can be great.
Contact us for further advice on pension issues, and help in choosing a pension that is right for you.
For further information on general pension planning issues, see Pensions