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Final salary schemes

The aura around final salary schemes means most people wouldn’t contemplate transferring their savings to a personal pension. Final salary schemes are, after all, the ‘Rolls Royce’ of pensions.

However, some recent events are leading to a growing number of people considering their options.

The catalyst for this changing attitude was pension ‘Freedom and Choice’, the biggest change to pensions in over 50 years. These changes allow savers to take their pension as they please and have dramatically improved the ability to pass leftover pension savings to the next generation.

A flexible pension is now a ‘must have’ for people in their 50s, 60s and beyond, as the savings plan from which to manage income, capital spending and inheritances.

At the same time as these new freedoms started, final salary pensions were going through some important changes of their own.

Firstly, final salary schemes have to put a higher value on the pensions that have been built up. Long-term interest rates are used to work out the today’s money value of pensions payable in the future. And because long-term interest rates have fallen to near record low levels, this means the today’s money value of pensions has never been higher.

On top of this, members of these schemes are getting older. This means that the trustees have to invest the scheme’s money in safer investments so that a stock market crash doesn’t prevent them from paying the pensions they promised. But lower-risk investments also means lower future investment returns.

The third big factor affecting final salary schemes is that their members are living longer. Men’s life expectancy at age 65 has been improving at about two years each decade over the last 30-40 years and women’s by about  one-and-a-half years every decade. This means than 65-year-old men are now living six years longer than they were 30 years ago and 65-year-old women about four-and-a-half years.

These three factors all exert an upward pressure on the cash value that final salary schemes must offer members wanting to transfer their savings to a personal pension. In fact, some transfer values are so high that members of these schemes can take the transfer value and buy a higher guaranteed income for life from an insurance company than they would have got from their final salary scheme.

This isn’t the case for all final salary schemes, and some still offer relatively stingy cash values for members that want to transfer their savings to another pension.

The only sure way to find out is to ask for a transfer value, which everyone under retirement age is entitled to do free once a year.

Another thing that is making people consider their options is the parlous state of some final salary pension schemes. Recently the BHS final salary scheme has been in the news, because the value of its investments is significantly less than it needs to pay the pensions the scheme has promised.

The UK does have an insurance scheme called the Pensions Protection Fund (PPF), which gathers up distressed final salary schemes and pays out pensions to the members of these schemes, when the sponsoring employer goes bust. However, the pensions that the PPF pays out may be less than promised by the final salary scheme.

Transferring a final salary pension scheme isn’t for everyone. People who are risk-averse, may rightly decide to stay put, especially if their own pension scheme is in good financial health.

But it does no harm to ask for a transfer value, and the most up-to-date trustees report concerning the financial standing of the pension scheme. This will allow you to assess the strength of the pension promise, and whether your other options, such as transferring to a new flexible pension, are better.