This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult us here at WMM (financial planning in Oxford).
There are many types of UK pension – with final salary pensions often referred to as “gold plated” ones. Also sometimes called defined benefit pensions, final salary pensions pay you a lifetime, guaranteed income in retirement – similar to a state pension.
Unlike a state pension, however, a final salary pension is paid by your previous employer and the amount is based on factors such as your years of service and pre-retirement salary, not your National Insurance contributions. Yet how attractive are final salary pensions, exactly? Are they worth holding onto, or is it better to transfer to a defined contribution scheme? Here at WMM, our Oxford-based financial planning team offers their thoughts.
A rare breed
In 2021-22 new membership to final salary pensions is very rare. Only a few companies and organisations outside the public sector still offer them to workers. Police officers and teachers typically have access to one, conditioned upon years of service (e.g. up to 35 years for the former). For employers, final salary pensions are increasingly deemed unaffordable due to longer UK life expectancies and more job mobility. One important difference exists between public and private sector final salary pensions, however. Whilst the former are paid out of UK taxation, the latter tend to be invested in pension funds (e.g. bonds and the stock market).
Hard-to-replicate benefits
Official guidance from the Financial Conduct Authority (FCA) is that most people with final salary pensions should remain with them, and not transfer out. This is partly because the benefits they offer can be very attractive and hard to replicate elsewhere. Furthermore, once you transfer out it is impossible to reverse your decision. So it’s important to seek professional financial advice and to be completely informed about your options.
One of the great advantages of a final salary pension is that you receive a guaranteed lifetime income in retirement. With a defined contribution pension (which involves building a pension pot over time), there is a possibility that you may run out of money in retirement – e.g. by taking out too much, too quickly. Here, you need to factor in any possible investment performance falls that could lower the value of your pension pot. With a final salary pension, however, you do not need to worry. Former public sector employees can rely on the UK tax system, and companies need to make up for any investment underperformance to keep providing the agreed income to you.
It is possible to generate a lifetime income another way – i.e. by buying an annuity; a financial product which you buy with your pension pot. However, income level may be lower compared to a final salary pension built up over a similar period.
Inflation protection
There are other advantages to final salary pensions. Yet one last one to mention here is the inflation protection they offer. Generally, such schemes link your retirement income to the rising cost of living over time. Defined contribution pensions can’t do this (unless you buy an annuity), and it helps preserve the spending power of your pension. At the moment, inflation is very low – about 0.9% in January 2021. Yet there could be a time when it is higher. In 1992, for example, it stood at over 7%. It can be very comforting, therefore, to have some pension protection.
Invitation
There certainly are situations where it can be wise to transfer out of a final salary pension. Yet, in general, most people would do well to hold onto their scheme. The benefits are still typically attractive in 2021, especially the guaranteed lifetime income – linked to inflation. It’s also worth noting that, given the high rates of UK job mobility today, you are likely to have the opportunity to build up defined contribution pots elsewhere as your career develops over the years.
Interested in finding out how we can optimise your financial plan? Get in touch today to arrange a free, no-commitment consultation with a member of our team here at WMM.
You can call us on 01869 331469
