cash clinic: what to do when the plug is pulled on final salary pensions

22nd May 2010

The Scottish private client and financial services team answer your queries, this week: the issues surrounding final salary pension schemes.

Q I work as an accountant for a small company which has recently closed its final salary pension scheme to financial accrual. How will this affect my retirement planning? What should I do with the final salary fund I already have? What other alternatives should I pursue to build up my pension?

A This scenario is not an isolated case, as an ever-increasing number of people are now faced with their final salary pensions being closed to future accrual or even wound up. This is because employers are faced with a growing pension funding gap, a predicament they blame on a combination of disappointing investment returns, changes to accounting standards, an increased regulatory burden, costly administration and increased life-expectancy.

Final salary pension schemes provide benefits based on the length of service and the final pensionable remuneration at the date of retirement, or in your case the date the scheme accrual ceased. For instance, a scheme may provide 1/60th of final pensionable remuneration for each year worked, meaning that a member could receive a pension on 50 per cent of final remuneration on retirement after working for 30 years.

While your scheme is now effectively closed to future accrual, you will not lose your entitlement to pension benefits built up to date and it will still form part of your income in retirement. Therefore, your benefits are safe providing the company does not default on its funding obligations, in which event your benefits may be protected by the government's pension protection fund.

Your company should have offered you entry into an alternative pension scheme, probably a money purchase (defined contribution) scheme such as a group personal pension. Unlike your final salary scheme, the benefits you will receive from this type of arrangement depend on the size of pension funds accrued and the rates used to convert pension funds to income. The available pension fund depends on the level of contributions paid and the performance of the investments selected. This means that, while you have more control over the investments of your pension and when benefits are drawn, you shoulder the risk over the level of benefit you will receive.

As your company will no doubt be making a pension contribution to the new scheme, it is highly likely that you should join. You could have the option of taking a cash equivalent transfer value in lieu of defined benefits and paying this into the new scheme. However, because the investment would be in a money purchase environment the potential risks of giving up a guarantee outweigh potential rewards for most people.

Pensions are one method of saving for retirement. As it is likely that your money purchase scheme will provide more modest benefits than the final salary scheme it replaces, you should also consider other complementary forms of saving.

Christian Poziemski is a wealth manager within the private client and financial services division of HBJ Gateley Wareing.