How does a final salary pension work?


If you are approaching retirement age, you may have found yourself wondering how a final salary pension works? Let’s take a look at the need-to-knows.

Guaranteed income for life

When you have spent your career working hard, you are entitled to get excited about the prospect of a long and happy retirement. One that’s free from financial concerns. A final salary pension can go a long way towards your financial wellbeing. It provides you with a guaranteed income for life. Better still, most final salary pensions adjust with inflation. So your income maintains its value.

How much will you receive from your final salary pension? That depends on a number of variables and your specific type of pension plan. Many final salary schemes are based on multiplying a percentage of your final salary by the number of years you were enrolled in the scheme. Whatever the nuances of your particular pension, final salary schemes are very attractive in terms of the security that they provide.

When can you begin drawing your final salary pension?

The age at which you can begin drawing your pension depends on a number of variables.  The majority of final salary schemes have rules regarding ‘normal retirement age’ – which is typically set at 60,65 or State Pension Age. You may be able to begin drawing your pension early, but doing so will reduce your annual payout.

Enjoy a tax-free lump sum to spend as you please

When you do decide to draw your pension, you can choose to take up to 25% of the pension value as a tax-free lump sum. How you spend this money is completely up to you – a cruise, home improvements or reinvesting, for example. However taking a lump sum out of your pension will reduce the annual income that you will receive. Choose carefully based on your personal financial situation.

What does it mean to transfer out of your final salary pension?

Final salary pensions are great for retirees, but expensive for employers. Pledging to pay you a guaranteed income for life is a big commitment – especially as life expectancy increases. For that reason some employers are offering pension-holders generous sums to – in effect – abandon their pensions.

This would provide you with a sizeable lump sum in exchange for forfeiting your guaranteed annual income. The payouts on offer can be very tempting. But try not to get carried away. When you transfer out of a final salary pension, it becomes your responsibility to manage your investment choices to ensure that you have enough money to sustain your retirement plans.

That’s not a decision to be taken lightly.

What about providing for your nearest and dearest?

Nobody likes to think of the unexpected. But with any retirement planning, it’s important to consider how you might be able to provide for your nearest and dearest after you’ve gone. Your final salary pension may be able to help, depending on the particular pension scheme that you are part of. It’s likely that your spouse would receive around half of your pension – in the form of monthly payments – in the event of your death. Dependents such as children under the age of 23 may also be entitled to a share.

It’s always best to talk to an adviser

You have every right to a comfortable retirement that’s free from financial struggles. Yet making that a reality can involve some complicated decisions – the outcomes of which can have a big impact on your future financial wellbeing. That’s why it’s always a good idea to seek the balanced advice of an independent financial adviser. By assessing your options with an expert you can make clear financial decisions, with the confidence that you are working smartly towards a secure retirement.

Would you like some advice from Prydis?

Our expert advisers have helped thousands of savers build a wealthy future. Even if you have lost the details of your pension scheme, we can help you to rescue your pension and build towards your future. It’s one of the reasons that we have earned our prestigious Chartered Financial Planners designation. Think of it as the gold standard for financial planning advice. Get in touch and let’s begin the conversation.

James Priday

This article was written by James Priday

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