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21st November 2019
:: Scheme Member | Types of Pension Scheme | What is a final salary scheme? | Active members of a DB scheme

What is a Final Salary Scheme? – Active Members
There are many types of pension scheme offered by employers for their employees. This Factsheet briefly looks at one of the most common variations that employers have run for their employees - the final salary scheme.
 
It is written for people who are active members of a final salary scheme.
 
 
 
 
  
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Introduction
 
A final salary scheme is a type of defined benefit scheme.
 
To understand what a final salary scheme is, you ought to know the very basics about employers’ pension schemes. See our Factsheets What is a pension scheme? and Types of employer sponsored pension schemes. There is also a more detailed explanation in our Factsheet, What is a defined benefit scheme? which you should read in conjunction with this Factsheet.
 
 
What is a final salary scheme?
 
Most final salary schemes provide benefits based upon 4 key elements:
  • the length of the pensionable service you are credited with as being an active member of the scheme
  • your pensionable salary
  • the formula or rate of ‘accrual’ which uses service and salary to work out your pension
  • the circumstances under which benefits are taken from the scheme (retirement, early payment, early leaver, ill-health, death etc).
Your pension scheme will use a formula to calculate your pension benefits using these elements. The formula (and the definitions for each part of it) will be set out in the Scheme Rules.
 
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.
 
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.
 
There are many different types of final salary schemes, each having its own formula to calculate members’ benefits.
 
Example of a ‘final salary’ formula:
 
length of pensionable service     x   final pensionable salary
          accrual rate
 
Two common examples of ‘final pensionable salary’ would be:
  • your last year’s pensionable earnings or
  • an average of your last 3 years pensionable salary.
An example of calculating pension benefits in a final salary defined benefit scheme for an active member retiring from service:
 
Jennifer Grant is an active member of her pension scheme, and is retiring from work. She will receive a pension from her employer’s defined benefit scheme. She has been a member of the scheme for 20 years and her final pensionable salary (which is what her pension is based upon) is £30,000 p.a. She earned a pension equal to 1/60th of her final pensionable salary for each year she was in pensionable service (the ‘accrual rate’).
 
Pensionable Service,             20 years
Final Pensionable Salary,      £30,000
‘Accrual rate’,                        1/60th
 
Her pension will be:              20 years    x    £30,000
                                                  60
 
                                             = £10,000 p.a.
 
Note, that in a final salary scheme your pensionable service is not necessarily the same length of time you have been employed by your employer. See our Quicknote, What is pensionable service?
 
Similarly, the salary used to calculate your pension benefit may not include all of your pay. For more information see our Quicknotes, What earnings are used in calculating my pension? and Does my scheme integrate with the State Pension?
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What is an accrual rate?
 
The ‘accrual rate’ is the rate at which you build up pension benefits whilst a 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
Final 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
Final 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 final salary scheme for example, you may accrue 1.25% of your final pensionable salary for each year of pensionable service. 
 
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Advantages of a final salary scheme
 
A final salary scheme links your pension benefits to your pensionable earnings in the years when you are closest to drawing your benefits. Because of this link, it allows you to estimate you pension benefits at retirement with some degree of accuracy, assuming the scheme continues and is able to pay pensions when they fall due.
 
A final salary 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.
 
In a final salary scheme, the sponsoring employer pays the lion’s share of the cost of providing benefits.
 
As well as these obvious advantages, a final salary scheme is also particularly advantageous to 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
Final salary pension schemes fall within the scope of The Pensions Regulator, so your scheme is monitored by a regulatory body.  
 
 
Disadvantage of a final salary scheme
 
It is not true that final salary schemes provide 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?
 
Your pension benefits will depend upon your final pensionable salary which may be difficult to predict some years into the future. If you experience a sudden unforeseen drop or decline in pensionable earnings (e.g. going part time), this may have a significant effect on your pension benefits.
 
Many employers have closed their final salary schemes, some just to new members, others having completely closed their scheme (so that there are no active members). Closing a scheme can cause employer costs to rise, as the increasing life expectancy of the remaining members (mortality risk) is one of the key problems pension schemes and employers have faced in recent years.
 
Burdensome and (some say) excessive legislation and regulation has further increased costs and placed greater financial pressures on sponsoring employers. 
 
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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 ‘final pensionable salary’ in the years immediately before you take your pension, but this can only provide an approximate figure.
 
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. 
 
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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 (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 scheme 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
 
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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 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? Is it a ‘final salary’ type scheme? If yes, what formula does it use to calculate your pension benefit?
  • 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 final salary scheme v3.2 - Active
Last updated 12/11/2008
 
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