The Death of Final Salary ?
In very broad terms, investors prefer guaranteed payoffs to risk, unless the potential returns far outweigh the additional risks being taken. Final Salary is a heavy burden for many companies now and there are some situations where the final salary scheme guarantees are now at risk due to deficits and underfunding. Hence, it is vital that you have a detailed review of all your pension arrangements so that you can determine whether Final Salary or Money Purchase is actually better for you in your circumstances.
(If you would like us to conduct an initial review for you, you can use e-Mail, telephone or the request for Pension / Financial Advice page to get in touch.)
Nevertheless, to help you understand more about the Final Salary vs Money Purchase considerations, please see below for an example of how, both, the pensions and corporate worlds have changed over the last four-plus decades and how that has affected the pensions landscape.
On 30th April 2011, a fascinating radio interview took place on BBC’s Money Box programme where experts discussed why Final Salary schemes were on their way to being closed to all members – new and existing.
Unilever Corporation was placed on display by the BBC as far back as 1967, as a shining example of the benefits of being loyal to a large organisation throughout your career i.e. a great pension to look forward to when you retire, namely “Final Salary”.
Roll on just over 40 years and that same company with a great British history of almost 150 years, is having to do 2 key things with its pension scheme :
New employees cannot be offered a Final Salary pension any longer.
Existing employees will have to be moved to a Money Purchase pension.
So, why all the fuss about Final Salary schemes? Are they genuinely superior to Money Purchase pensions? In short, “Yes” and “No” (but generally “Yes”).
The major advantage of a Final Salary scheme compared to a Money Purchase pension is that the risk is transferred to the Employer and not the Employee. Obviously, this is not so good for the company but for you as an Employee it’s much preferred.
Final Salary pensions have the following basic method to enable you to calculate your pension income when you retire which goes as follows :
Number of Years Service x Accrual Rate x Pensionable Salary
This is just the basic calculation and is only the starting point but it is the calculation at the centre of how a Final Salary pension is worked out. Clearly, detailed figures are required for you to know more accurately what the pension income in retirement will be. A Financial Planner will be able to conduct the necessary review and/or calculations on your behalf.
Your “Accrual Rate” is simply the fraction of your salary that you accrue for each year of service to the company. For example, if you are in a “fortieths” scheme, when you retire you will receive 1/40 of your pensionable salary for each year of service with the company. Hence, if you worked for a company for 40 years and, let’s say, you were in a fortieths scheme with a pensionable salary of £32,000 per annum at your retirement date, this is what you could potenially receive as your pension income in retirement (subject to detailed calculations of course):
40 years x 1/40 x 32,000 = £32,000 p.a.
In short, you would receive 100% of your pre-retirement salary every year until you die! Furthermore, this would have been contractually agreed to by your employer and guaranteed throughout retirement until the day you pass away. Evidently, Final Salary pensions are indeed valuable.
Let’s briefly compare this with a Money Purchase pension scheme :
Assume you make the same level of contribution as your Final Salary colleagues. Where they are given a prescribed value to each year of service to the company, you have to build up your own “pension fund” in your own name without any guarantee of the income in retirement. Your sole aim is to create as large a fund as possible and then go into the market place at retirement and say something like :
“Who will give me the largest income every year with this pension pot of money?”
The differences between the two are stark – one you can work out in advance and is guaranteed (unless the company or pension scheme become insolvent which creates a whole host of other problems), whereas the Money Purchase pension is not known in advance at all and is down to the skill and judgement of what we call your Pension Management Team i.e.
Your selected Pension Provider / Administrator
The nominated Fund and Investment Manager
The trusted Financial Planner and Adviser
With a carefully selected Pension Management Team, a detailed pension review and a financial plan to execute, you maximise the potential of a Money Purchase pension. It may not be guaranteed and the risks may appear to be higher; however, that is the environment in which we now find ourselves.
When you are ready, do get in touch using e-Mail, telephone or the Financial Advice request page and we will help you put your team together.