Final salary pension is often considered the standard for retirement savings as it seems to be the best in the market. If you are in a final salary pension scheme, it means you will be paid retirement allowances depending on your final salary at retirement. In simple words, you will receive retirement income forever, and the amount of retirement is calculated using your salary when you retire.
The final salary pension may not be flexible, but the benefits upon retirement are really valuable. It is still the gold standard in many public sectors for civil servants. The retirement amount you receive is also based on the number of years you have been a scheme member.
How does it work?
You are probably wondering how final salary pensions work. Once you enroll for a final salary pension scheme, your employer sends your pension contributions directly to your pension fund. So, the scheme is the entity that also gets to decide when you should retire, which is when you should start receiving your retirement income.
The best thing about final salary pensions is that most of them are index-linked, which means that the retirement income you receive increases every year to keep up with the rising cost of living. The pension also comes with other benefits, including:
- Early pension is whereby you can retire early on a reduced pension if you want to resign from your work before your retirement age.
- Death in service payout means that your spouse or dependant can continue receiving your pension payouts if you die before your retirement age.
- Ill health pension- you may get your pension income early if ill health forces you to retire before your retirement age.
How is the final salary pension calculated?
Your final salary pension is calculated based on the following factors:
- Your final salary or average salary depending on your pension scheme.
- Your years of service in the pension scheme.
- The retirement scheme’s accrual rate means the proportion of your payouts that you will get as a pension for every year in the scheme.
You can work out your retirement income through your pension statement. Many schemes produce one every year, which indicates your projected pension income according to your salary and how long you’ve been in the system.
Can you take a lump sum from your final salary pension?
Many pension schemes allow you to take 25% of your pension scheme after you have reached 55 years. It is usually a tax-free sum. But it is very complicated when it comes to final salary pensions. To work out how much you can take, you should consider your scheme’s commutation factor. That shows you how much lump sum you will earn for every dollar you give up. For instance, if your commutation factor is ten, you earn a lump sum of ten dollars for every one dollar you give up.
Final salary pensions offer a set of income in retirement for life. Unlike defined contribution pensions, your employer is obligated to ensure you have enough funds in your pension to pay you upon retirement. Plus, final salary pensions also come with other benefits such as early pension and death in service payout.