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20th March 2019
:: Scheme Member | Important Aspects of My Pension | What earnings are used in calculating my pension? | Active members of a DB scheme

What earnings are used in calculating my pension? Active Members
This Factsheet is written for people who are active members of an employer’s pension scheme.  
 
Introduction
 
This Factsheet looks at pensionable salary which is important in terms of your retirement planning. It is essential that you understand which earnings are included in your pensionable salary and as importantly which are not
 
Some of the points are more obvious than others, but they are all important.
 
If you are intending to get advice from a Financial Adviser these are some of the things you should be discussing with them. This is essential if your total earnings from your employment are much greater than your pensionable salary as this may produce a significant shortfall in terms of your income in retirement.
 
This Factsheet forms part of our Module Important Aspect of My Pension and should be read alongside the other Factsheets and Quicknotes in the series.
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Contributions to your pension scheme
 
Since 6th April 2006, there is now no limit on the amount that YOU (as an individual), or your employer on your behalf, can contribute to registered pension schemes. You can put as much as you want into your pensions but you may not receive tax relief on all of your contributions.
 
This is because there is a ceiling on the amount of contributions you can make in any tax year and receive tax relief – this is called the Annual Allowance, (see our Module, A-Day: New Regulations from April 2006). You can receive tax relief each tax year, on contributions equal to the greater of: 
  • £3,600 (gross) and
  • 100% of your taxable earnings (including any benefits in kind) up to the Annual Allowance
If YOU personally pay more than this amount, you will not receive any tax relief on the excess.
 
You can now also pay into as many registered pension schemes as you wish, concurrently. So, if you are an active member of your employer’s pension scheme you may also contribute to any other registered pension scheme, such as a Personal Pension Plan. However, you should seek Financial Advice before you do this.
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Pensionable salary
 
Your pensionable salary is very important as your pension benefits will depend upon it, one way or the other.
 
The calculations of pensionable salary can be very complex and can involve factors such as maximum amounts to be taken into account, or exclusions of certain types of earnings.
 
All employer sponsored pension schemes will have their own definition of what is pensionable salary and schemes will be different to one another. 
 
Pensionable salary only includes those earnings which are listed in the Scheme Rules.
 
Typically, pensionable salary could include: 
  • Basic Salary
  • Shift Pay
  • Bonus
  • Overtime
  • Commission
  • Location Allowances
  • Benefits-in-Kind
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Examples of pensionable salary
Employer A
 
Pays a basic salary of £30,000 p.a., plus a further £8,000 p.a. in bonus/overtime.
 
For pension purposes, it allows employees’ full earnings to be used as pensionable salary.
 
So, the full £38,000 is used in calculating pension benefit.
 
Employer B
 
Pays a basic salary of £33,000 p.a., plus a further £15,000 p.a. in bonus/overtime.
 
For pension purposes, it allows only employees’ basic salary to be used as pensionable salary.
 
So, only £33,000 is used in calculating pension benefit.
 
 
Sometimes, a scheme’s Rules will define pensionable salary in such a way that it uses an average of certain types of earnings where there is likely to be significant fluctuations.
  
Example of averaging certain earnings which go towards pensionable salary:
 
pensionable salary = basic salary + average of the last 3 years bonuses
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Final salary schemes
 
A final salary scheme is a type of defined benefit scheme and will use a formula to calculate your pension benefits using 4 key elements. The formula (and the definitions for each part of it) will be set out in the Scheme Rules.
 
Because your pensionable salary is used as one part of the formula in order to calculate your pension, a final salary scheme is commonly referred to as ‘salary related’ scheme.
 
In a final salary scheme your pension is based upon your final pensionable salary in the years immediately before you take your pension. Different schemes use different definitions, so it is the definition of your ‘final pensionable salary’ (or ‘final pensionable earnings’) that is important in this type of scheme.
 
There are many different types of final salary schemes, each having its own formula to calculate members’ benefits.
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Example of a final salary formula:
 
length of pensionable service     x   final pensionable salary
          accrual rate
 
Three common examples of final pensionable salary would be: 
  • your last year’s pensionable salary
  • an average of your last 3 years pensionable salary
  • an average of the best 3 consecutive years pensionable salary over the 10 years before pension benefits are taken. 
It’s a fact of life that most of us slow down a little as we grow older. If you are in a physically or mentally demanding job, will you continue to be able meet these demands? If you change jobs within the same employment, would you earn the same? Will your pensionable salary drop? If so, any decrease in your earnings immediately before you draw your pension benefits could have a significant impact upon your retirement provision from a final salary scheme.
 
In a final salary schemes, your contributions are usually expressed as a percentage of your pensionable salary, e.g. 7% employee with your employer paying the balance of the costs to fund the promised pensions (with the exception of some Public Sector schemes).
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Career average revalued earning schemes (CARE schemes)
 
A CARE scheme is a type of defined benefit scheme and it too uses a formula to calculate your pension benefits using 4 key elements. The formula (and the definitions for each part of it) will be set out in the Scheme Rules.
 
In a CARE scheme, usually each year’s pensionable salary is revalued (increased) to allow for inflation between the date it was received and the date on which benefits become payable (called inflation adjustment). The total of your pensionable salary is then averaged out by dividing it by the number of years you were a member of the pension scheme.
 
Example of a ‘CARE scheme’ formula:
 
length of pensionable service     x   averaged pensionable salary
          accrual rate
 
The definition of your pensionable salary is important in this type of scheme.
 
The ‘inflation adjustment’ could be structured in many ways, but would be based upon one of the Prices Inflation Indexes (such as RPI or CPI) or in a generous scheme on Average Earnings increases.
 
In a CARE scheme, your contributions are usually expressed as a percentage of your pensionable salary, e.g. 7% employee with your employer paying the balance to fund the promised pensions (with the exception of some Public Sector schemes).
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Money purchase schemes
 
A ‘money purchase scheme’ provides benefits based upon the amount of money that is in YOUR own pension ‘pot’ when benefits are due to be paid.
 
The amount that will be in your ‘pot’ when benefits arise will depend upon the payments made into your ‘pot’; the investment return achieved on each individual payment to the pot; and any costs which are charged against your growing ‘pot’. The benefits you or your dependents will get from a money purchase scheme will come entirely from your ‘pot’.
 
The contributions that your employer and YOU make to the money purchase scheme will be based upon your earnings and in this respect your pensionable salary is important. As with other types of employer sponsored schemes, calculating your pensionable salary can be quite complex involving factors such as maximum amounts of your earnings which can be taken into account, or exclusions of certain types of earnings.
 
In an employer sponsored money purchase scheme, your contributions are usually expressed as a percentage of your pensionable salary, e.g. 5% employee, 7% employer contributions.
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Summary & Key Points
 
When making enquiries about your pension benefit it is very important that you make it clear that you are an active member rather than a preserved member or pensioner member. Active, preserved and pensioner are different classes of membership of a pension scheme and any definitions and paragraphs contained within your Scheme Rules or scheme literature relating to any benefit may differ considerably between these categories.
 
You need to consider the following items: 
  • What are your total earnings from your employment?
  • What is your pensionable salary? What earnings are included or excluded from your pensionable salary?
  • Is your pensionable salary much less than your total earnings? If ‘yes’, will this mean that you will have shortfall in your retirement planning?
  • Keep informed. Your scheme may modify benefits and Rules. Legislation may change. Your circumstances may alter.
  • Rules differ from scheme to scheme and are wide and varied in content. Don’t assume that what applies to one of your pension schemes will necessarily apply to others that you may have.
  • HMRC impose rules which registered pension schemes must conform to.
People seldom have identical pensions and you should avoid drawing comparisons with colleagues whose circumstances may at first appear the same but could emerge as having significant differences.
 
This Factsheet forms part of our Module Important Aspects of My Pension and should be read alongside the other Factsheets and Quicknotes in the series.
 
This is not an authoritative document. Seek professional advice from an appropriately experienced and qualified adviser.
 
 
What earnings are used in calculating my pension v3.0 Active
Last updated 16/01/2007
 
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Glossary
View our Glossary for definitions of the terms used in our Factsheets
 

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What earnings are used in calculating my pension? - Active Members
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