April 8th, 2020

Pension advice: how does a final salary pension work?

You’re looking for clear advice on a simple question: how does a final salary pension work? Here’s everything you need to know – in plain English.

Say hello to guaranteed income for life

Chances are you are hoping for a long and happy retirement – and certainly one that’s financially secure. Good news. A final salary pension provides you with a guaranteed income for life. That means it can go a long way towards supporting your financial wellbeing. Even better, most final salary pensions track inflation. So your income maintains its value.

The big question is: how much can you expect to receive from your final salary pension?

That depends on a number of variables. Many final salary schemes are based on multiplying a percentage of your final salary by the number of years you were enrolled in the pension scheme. Your pension scheme provider will be able to tell you more. But whatever the nuances of your particular pension, the takeaway point is that final salary schemes are highly attractive in terms of the security they give you.

When can you start drawing from your final salary pension?

Next question: at what age can you begin drawing from your final salary pension? Again, that depends on the rules laid out by the provider of your pension scheme. Most final salary schemes will impose a ‘normal retirement age’ – which is usually set at age 60, 65 or State Pension age. Now, some schemes will allow you to begin taking your pension early. But there will almost always be financial penalties for doing so, which will reduce the value of your retirement pot. In short: even if your scheme allows you to take your pension early, it’s often best to wait.

Enjoy a tax-free lump sum. Yours to spend as you wish.  

The day has come. After a long career of working hard, you have reached retirement age and you are ready to put your feet up. It’s time to begin drawing from your pension. And to kick things off you can choose to take up to 25% of your pension value as a tax-free lump sum.

You can spend this money on whatever you wish – a Mediterranean cruise, home improvements or reinvesting, for example. Yet just because you can doesn’t always mean you should. Taking the lump sum option will reduce the annual income that you will receive for the rest of your retirement years.

There’s no right or wrong answer.

It’s all about making the right choice for both your financial circumstances and your retirement ambitions.

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

You may have heard about people ‘transferring out’ of their final salary pension.

This is not a decision you should take lightly – and here’s why. 

Final salary pensions are great for retirees like you (or future you), but expensive for employers. In effect your employer is promising to pay you a guaranteed income for life. It’s a big commitment – especially as life expectancy is increasing. That’s why some employers are offering generous sums to those with final salary pensions to – effectively – buy you out of your pension.

This would provide you with a sizeable lump sum – and the pay outs on offer can be tempting. But in exchange you are forfeiting the security of an annual income that’s guaranteed for life. Think objectively and try not to get carried away. Taking the lump sum could put more pressure on your investment choices to sustain a comfortable retirement.

What about providing for your nearest and dearest?

It’s not the most enjoyable thing to consider. But with any retirement planning, it’s necessary to think about 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.

Each scheme varies but, after you’ve gone, it’s likely that your spouse would receive half of what remains of your pension – which would take the form of monthly payments. Dependants such as children under the age of 23 may also be entitled to a share.

It's always best to talk to an adviser  

Creating a comfortable retirement that’s free of financial difficulties can involve some complicated decisions – the outcome of which can have a big impact on your future financial security. With high stakes like that, it’s always best to seek the balanced and experienced guidance of an independent financial adviser. A little input can bring you a lot of peace of mind that you are making sensible decisions for your future.

Would you like some advice from Financial Solutions?

Our independent advisers have helped thousands of savers build a wealthy future. Get in touch and let’s start the conversation.

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