Because both types of scheme use your pensionable salary as one part of the formula in order to calculate your pension, they are both commonly referred to as ‘salary related’ schemes, but there is a significant difference between the two.
Example of a ‘final salary’ formula:
length of pensionable service x final pensionable salary
accrual rate
A ‘final salary’ type defined benefit scheme would use your pensionable earnings near to the date when you draw your pension benefits. 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.
A common example of final pensionable salary would be your last year’s pensionable earnings.
Example of a ‘CARE scheme’ formula:
length of pensionable service x averaged pensionable salary
accrual rate
A CARE scheme uses your averaged pensionable earnings over the lifetime of your active scheme membership.
It is therefore, the definition of your pensionable earnings that is important in this type of scheme. Usually, the pensionable earnings used are increased (called inflation adjustment) to allow for inflation between the date they were received and the date on which benefits become payable.
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.
What is a CARE scheme?
As we have established, a career average revalued earnings scheme, uses the average of your pensionable earnings over the entire period that you are an active member of the pension scheme.
Example of a ‘CARE’ defined benefit scheme:
Pauline Lewis is an active member of her pension scheme, and is retiring from work. She will receive a pension from her employer’s CARE scheme. She has been a member of the scheme for 5 years. She earned a pension equal to 1/60th of her averaged pensionable salary for each year she was in pensionable service (the ‘accrual rate’).
To calculate her averaged pensionable salary, her pensionable salary is increased by the rate of inflation each year up to retirement, whereupon it is then averaged over the years she has been a scheme member. Inflation was 3% at the end of year one, 2.5% at the end of year two, 3.5% at the end of year three, 2% at the end year four and 1.5% at the end of year five.
The calculation would look something like this:
Pensionable Inflation adjustment inflation adjusted
Salary pensionable salary
£21,000 x 3% x 2.5% x 3.5% x 2% x 1.5% = £23,754
£24,000 x 2.5% x 3.5% x 2% x 1.5% = £26,359
£23,000 x 3.5% x 2% x 1.5% = £24,645
£31,000 x 2% x 1.5% = £32,094
£34,000 x 1.5% = £34,510
making a total of = £141,362
So her total pensionable salary is £141,362. This is then divided by the number of years she was a scheme member – i.e. 5 years, making an averaged pensionable salary of £28,272 (£141,362 divided by 5).
Her pension at retirement would be:
Pensionable Service, 5 years
Averaged Pensionable Salary, £28,272 (£141,362 / 5)
‘Accrual rate’, 1/60th
Her pension is: 5 years x £28,272
60
= £2,356 p.a.
Usually, the earnings used are increased to allow for inflation between the date the earnings were received and the date on which benefits become payable. The ‘inflation adjustment’ could be structured in many ways, but would generally be based upon one of the Prices Inflation Indexes (such as RPI or CPI) or in a more generous scheme, on Average Earnings increases.
There are many different types of CARE schemes, each having its own formula to calculate members’ benefits.
Note that in a defined benefit scheme (whether ‘final salary’ or CARE’), your ‘pensionable service’ is not necessarily the same length of time you have been employed by your employer.
Similarly, the salary used to calculate your pension benefit may not include all of your pay.
What is an accrual rate?
The ‘accrual rate’ is the rate at which you build up pension benefits whilst an active member of the pension scheme.
It is most commonly expressed as a fraction, such as 1/30th, 1/60th, 1/80th, 1/120th etc. The lower the bottom number, the better the pension benefit you will receive for an equivalent amount of pensionable service e.g.
Example 1, using a 1/60th ‘accrual rate’
Pensionable Service, 20 years
Averaged Pensionable Salary, £30,000
‘Accrual rate’, 1/60th
Pension: 20 years x £30,000
60
= £10,000 p.a.
Example 2: using a 1/80th ‘accrual rate’
Pensionable Service, 20 years
Averaged Pensionable Salary, £30,000
‘Accrual rate’, 1/80th
Pension: 20 years x £30,000
80
= £7,500 p.a.
An accrual rate can sometimes be expressed as a percentage e.g., 1.25% (which is simply another way of saying 1/80th in this example). So, in a CARE scheme for example, you may accrue 1.25% of your averaged pensionable salary for each year of pensionable service.
Advantages of a CARE scheme
In a CARE scheme, the sponsoring employer pays the lion’s share of the cost of providing benefits.
A CARE scheme also provides members with protection from ‘investment risk’ and ‘mortality risk’ as it is the sponsoring employer (or taxpayer in respect of some Public Sector schemes) who shoulders this risk. For more details on these and other risks, see our Factsheet, Security and Risk.
As well as these obvious advantages, a CARE scheme is also particularly advantageous to active members whose pensionable earnings:
- fluctuate significantly, (a sales person whose earning depend upon performance-related targets for example)
e.g. £29,000; £28,000; £24,000; £29,000; £31,000
- are likely to reduce the closer the member gets to retirement (because of declining physical or mental abilities for example)
e.g. £31,000; £29,000; £27,000; £26,000; £25,000
- are unlikely to increase significantly in the years immediately before retirement (those whose earnings don’t vary much for example)
e.g. £21,000; £21,500; £21,750; £21,500; £21,800
For those people who experience a sudden unforeseen drop or decline in pensionable earnings (e.g. going part time), the averaging effect of a CARE scheme takes the pain out of a reduction in income, and the corresponding effect that would have on retirement.
A CARE scheme falls within the scope of The Pensions Regulator, so the scheme would be monitored by a regulatory body.
Disadvantages of a CARE scheme
CARE schemes provide a promised (rather than a guaranteed) retirement pension. The pension benefit paid will depend upon many factors, with the most important being the scheme’s ability to pay benefits to members as they fall due. If the employer’s business fails, it is likely that benefits will be reduced for some, if not all members (although Public Sector schemes are different in this respect). For further information on this, please refer to our Module, How secure is my pension?
With no link to members’ pensionable salary close to retirement, a CARE scheme could be less beneficial (to a comparable ‘final salary’ scheme) for scheme members:
- whose pensionable earnings are likely to rise regularly (or consistently) throughout their career, ahead of inflation-
e.g. £29,000; £30,000; £32,000; £33,000; £34,000
- whose pensionable earnings are likely to rise through promotion or career progression -
e.g. £29,000; £30,000; £38,000; £39,000; £45,000
Burdensome and (some say) excessive legislation and regulation has further increased costs and placed greater financial pressures on sponsoring employers.
When can I get my pension benefits?
Benefits will normally be payable to you when you reach your scheme’s normal pension age or Normal Retirement Date. This is important as it is the date at which you would normally be expected to start to draw your pension benefits without the consent of the employer or the Trustees.
Depending upon the rules of your scheme (not all schemes allow these alternatives), you may also be entitled to receive benefits at other dates such as:
- Early retirement
- Retirement due to ill-health
- Terminal illness
- Late retirement (where you choose to work beyond normal pension age)
What are my benefits worth?
We know that your benefits will be calculated based on your averaged pensionable earnings as you progress through employment, but this can only provide an approximate figure. The final calculation at the time you are due to take your benefits will depend upon the ‘inflation adjustment’.
The ‘value’ of the benefits depends upon other factors which are personal to you (such as the inclusion of dependents’ benefits, pension increases after retirement etc).
If you want to investigate this further, you should consult an independent financial adviser who is experienced in advising on defined benefits.
Are my benefits secure?
They are only as secure as the funds which have been set aside to pay for the benefits, and the employer’s willingness and ability to continue to support the scheme.
In the event of the employer going into receivership, if the scheme does not have sufficient funds to pay all benefits it is possible that the scheme might qualify to join the Pension Protection Fund which would provide a level of ‘compensation’ (but might still mean a reduction in your benefits). There are some schemes that don’t qualify for the Pension Protection Fund, such as Public Sector schemes. For further information on this, please refer to our Module, How secure is my pension?
After you retire, your benefits will be more secure.
Can my benefits and contributions be changed?
Any changes in pensions’ legislation might mean that the scheme has to change.
Otherwise, there are legal requirements that certain changes can only be made after consulting some classes of members. All benefits you have already earned cannot be changed including any future inflation adjustment to those benefits (unless your scheme is wound up). Any improvements which don’t involve you in a higher cost would not require your consent. You would however be told of any change.
What rights do I have as a member to ensure the scheme is run properly?
Any member can seek election to become a Trustee of their pension scheme, where there is a Board of Trustees. A Trustee is responsible for ensuring the scheme operates according to all the rules.
If you are unhappy about any aspect of the scheme contact the Trustees and if they do not satisfy you having formally pursued the Internal Dispute Resolution Procedure, you can contact The Pensions Ombudsman or The Pensions Regulator depending on your problem. Also, see our list of Useful Contacts.
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 of the scheme 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.
For each pension benefit you need to consider the following items:
- Is your pension scheme a defined benefit pension scheme? If yes, is it a CARE type or final salary type?
- How much of your earnings, including any bonuses, overtime, allowances and benefits in kind, go towards your pension earnings? Will your earning reduce the closer you get to retirement?
- What is the formula or ‘accrual rate’ used in calculating your pension benefit? Has this changed at any time during your membership of the pension scheme?
- Is there any reduction to the amount of earnings that go to calculating your pension benefits?
- What pension benefits are provided by your pension scheme? Pension, lump sum, death benefits, ill-health benefits, early payment, pension increases?
- 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 Types of Pension Scheme 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 is a career average scheme v3.2 - Active
Last updated 13/01/2007
