Final Salary Pension Benefits

by Niki Gahan on 16·02·2016

There is no doubt that final salary schemes offer valuable benefits; guaranteed income from the scheme's normal retirement age, increasing income in line with inflation, spouse's pension on death of the member both pre and post retirement.   However, as widely acknowledged, since the 2016 pension legislation changes there has been a significant increase in demand for cash equivalent transfer values.

It is imperative to weigh up the value of the final salary pension benefits based on an individual's circumstances. The critical yield, indicating the level of annual growth required of the transfer value to match the benefits provided by the final salary scheme, is only one factor to take into account.

What is the actual value of the final salary benefits to the individual? What are their retirement objectives and attitude to risk? Guaranteed income and a spouse's pension is going to have a much greater worth to someone married or in a civil partnership with no other financial provision in retirement than someone whose final salary benefits represent a relatively small part of their assets.

Death benefits are a particularly important consideration. What level of spouse's pension is available via the final salary scheme? Often 50%, some schemes may provide more. Furthermore, what dependents pension may be payable to children and until what age? If these benefits were transferred into a money purchase plan, would a return of fund be more valuable to the individual's spouse and or family? It would certainly provide greater flexibility in terms of how death benefits can be taken, as well as the ability to pass funds through generations.

Another important consideration is the greater freedom nominating death benefits. The nominated beneficiary subsequently has the ability to pass unused drawdown funds on death to their own beneficiary, rather than the original member. If the original nominated beneficiary dies before the age of 75, the successor can receive a tax free lump sum or draw benefits tax free through drawdown. If the beneficiary dies aged 75 or over then any benefits can either be taken by the successor as taxable drawdown income or a lump sum taxed at 45%. Not only does this keep pension funds alive, it provides the potential to pass pension funds down through the generations without ever falling into anyone's estate for Inheritance Tax purposes. The funds can remain invested in a tax advantaged environment and have the potential to provide a tax free income where the member or beneficiary dies before age 75.

Traditionally it's been considered that money purchase schemes offer a worse deal than final salary schemes. Today the transfer of final salary benefits has quickly become a viable option; not only in relation to the additional flexibility a money purchase arrangement provides, but also in respect of the death benefits. Although imperative to highlight what final salary benefits would be lost upon transfer and ensure viabilty in terms of the clients health and proximity to retirement etc, it does need to be considered in light of the client's objectives and circumstances.