Final Salary Scheme, (Defined Benefit Scheme)

The pension you will receive from a final salary scheme is normally based on your final pensionable salary and the number of years you have been a member of the scheme.

A pension transfer from a salary-related pension scheme means giving up your benefits in the pension scheme in return for a cash lump-sum. You cannot normally take this cash lump-sum to spend now, as it must be transferred to another approved pension scheme. 

The Transfer Value

In order to evaluate whether it is a good idea to transfer the pension benefits, the benefits must first be valued by the scheme’s trustees. This value is offered by the scheme’s trustees as a lump-sum, which if you decide to transfer is paid to the receiving scheme’s trustees.  

Some schemes offer discretionary benefits to members, these are benefits that the scheme or your employer may give you but are not obliged to give you. Discretionary benefits can be very valuable, such as increases to your pension when you retire. As a consequence however of the benefits being discretionary, their value may not be reflected in the transfer value. 

Therefore, if you are considering transferring your pension it is important to ALWAYS find out whether the pension transfer value takes into account any discretionary benefits.  

Where a scheme is under funded the transfer value may be offered on a reduced basis.

Pension Transfer Incentives  

Some employers offer an incentive for you to transfer your pension. This can be an offer of a cash payment to you. Where the transfer incentive is paid in cash, you may have to pay income tax and possibly national insurance on it. Alternatively, you will get a larger pension if you accept the incentive as an enhancement to your transfer value. 

Where Can A Scheme Transfer To? 

Pension Transfer from a salary-related scheme to another

salary-related scheme 

A new employer’s salary-related scheme may offer you ‘added years’ in exchange for your transfer value. These increase the number of years used in the scheme formula to work out your pension and other benefits. 

Pension Transfer from a salary-related scheme to a new employer’s

money-purchase scheme  

The benefits you get will depend on the size of the lump sum transfer how well investments perform; any charges raised on your pension, as charges will reduce the value of your investment and the annuity rates available at the time you retire, together with the type of annuity you choose. 

Pension Transfer from a salary-related scheme to a personal pension 

You can use your transferred lump sum to buy a personal pension. The benefits you get will depend on the size of the lump-sum transfer, how well investments perform; any charges raised on your pension as charges will reduce the value of your investment and the annuity rates available at the time you retire, together with the type of annuity you choose. 

Pension Transfer from a salary-related scheme to a buy-out contract 

You can use your transferred lump sum to buy a policy from an insurance company, which will provide you with a pension in the future. Buy-out contracts offer differing levels of guarantee and the benefits you get may depend on how well investments perform. Your pension will also depend on annuity rates at the time you retire and the type of annuity you choose.

Risks - Of Staying In Your Salary-Related Scheme

A final salary scheme is effectively a promise from the employer to contribute enough money into the pension now and in the future to provide the promised pension at retirement.  This is not risk-free, as some sponsoring employers have gone out of business and there hasn’t been enough money to pay the pensions promised.    

While the Government set up the Pension Protection Fund, which pays compensation to members of ‘failed’ salary-related pension schemes. The compensation is usually less than the pension that would have been paid if the employer had stayed in business.  

Risk - Of Transferring To A Money Purchase Scheme

If you are looking to transfer you pension to a money purchase scheme, you will need a detailed analysis of the rate at which your investments need to grow to match the benefits you would give up if you transfer. This rate is usually known as the ‘critical yield’.  

You will also have to make a judgement about whether the critical yield is achievable. Generally, the higher the critical yield required, the less likely this is to be achieved and the greater investment risk you need to take to achieve it. 

The cost, potential loss of benefits and risks of transferring from a salary-related pension scheme to a money purchase pension scheme often outweigh the advantages.

When Not To Transfer

• Do not transfer from a pension scheme provided by your employer if they are currently making contributions to the scheme.   
• If you are risk averse you should probably not leave a "defined benefit" (final salary scheme) as benefits are effectively a promise from the employer to contribute enough money into the pension now and in the future to provide the promised pension at retirement.   
• Whereas, money transferred to a personal pension will be invested and subject to investment risk. 
• If you left a final salary pension scheme after 31/12/1990 the scheme must increase this deferred pay by the Retail Price Index (R.P.I.) capped at 5%.   
• However, some schemes, usually in the Public Sector will be more generous and allow their members’ pensions to increase in deferment at the same rate as the R.P.I. without imposing an upper limit of 5%, regardless of how high it may rise in the future.   
• Therefore - do not transfer from a public sector pension scheme, such as the nurses' or the teachers' scheme, even if you left their employment several years ago. These schemes also allow you to link periods of service if you return to public service after several years of absence.