Defined benefit/final salary schemes

Defined Benefit Pension also known as a Final Salary Pension or Superannuation Scheme

A defined benefit pension plan is a type of pension plan in which an employer/sponsor promises a specified pension payment, lump-sum or combination thereof on retirement that is predetermined by a formula based on the employee's earnings history, tenure of service and age, rather than depending directly on individual investment returns. Traditionally, many governmental and public entities, as well as a large number of corporations, provided defined benefit plans, sometimes as a means of compensating workers in lieu of increased pay.

These schemes have become rarer in recent years as the employer/sponsor’s have no indication of the eventual cost to them in providing the scheme. Further the company’s directors may be held liable for any shortfall in the pension scheme’s funding. For this reason many employers have moved away from offering DB schemes in order to limit their liability.

A defined benefit plan is 'defined' in the sense that the benefit formula is defined and known in advance. Conversely, for a "defined contribution retirement saving plan", the formula for computing the employer's and employee's contributions is defined and known in advance, but the benefit to be paid out is not known in advance.

The most common type of formula used is based on the employee's terminal earnings (final salary). Under this formula, benefits are based on a percentage of average earnings during a specified number of years at the end of a worker's career.

In the private sector, defined benefit plans are often funded exclusively by employer contributions. For very small companies with one owner and a handful of younger employees, the business owner generally receives a high percentage of the benefits. In the public sector, defined benefit plans usually require employee contributions.

Over time, these plans may face deficits or surpluses between the money currently in their plans and the total amount of their pension obligations. Contributions may be made by the employee, the employer, or both. In many defined benefit plans the employer bears the investment risk and can benefit from surpluses.

Pension Sharing Orders

What is a pension sharing order and how do I apply for one?

• What happens next?

• When is pension sharing a good idea? Divorce is a stressful time. The end of any relationship is difficult, both emotionally and practically. Dividing up the assets you share as a married couple is one of the toughest parts of a separation.

Anything you have under a shared name must be considered. Your assets could include property, money in the bank, and pensions. Since divorce pension sharing was introduced in December 2000, pensions must be included in a divorce settlement. In other words, pensions are part of the total value of marital assets you share.

However, pension sharing isn’t always the first thing divorcing couples think of. Typically, most people focus on what will happen to the family home. But pensions are a huge asset and important when planning your future – so deciding what to do with them is extremely important.

 There are three options for dividing up pensions as part of a divorce:

• Sharing - Pension sharing is a formal agreement to divide your pension assets at the time of divorce. The courts work out exact percentages and the receiving party can become a member of the pension scheme or transfer the value to a new pension provider

• Offsetting - The value of the pension is offset against other assets. For example, one spouse keeps their entire pension, and the other is given alternative assets (e.g. property or cash) of the same value

• Earmarking - All, or part, of the pension is earmarked to be paid to one party when the other starts to draw pension benefits. There is no legal transfer of ownership

This guide will talk specifically on pension sharing. It’s a good option for many people because you can make a clean break from your ex-partner. Once pensions are divided up or a new pension is created for the receiving spouse, you don’t have to worry about it again.

What is a pension sharing order and how do I apply for one ?

If you’ve decided pension sharing is the right option for you, it’s important to know it can only happen with a court order. The pension sharing order sets out how much of a pension(s) will be given to you or your ex-spouse. This makes pensions different to other marital assets, such as the family home – which can be transferred to one spouse or the other. This may be agreed between both parties and recorded through solicitors without going to court.

So why can’t the same be done for pensions? Well, pension providers or pension schemes cannot carry, divide or transfer any pension without instruction from the court. That doesn’t mean you’ll spend any time stood up in a courtroom, though.

Once your marital assets have been assessed, the court will award a percentage of one party’s pension value to the other person. The amount awarded is referred to as a pension credit, and the amount deducted from the other party is known as a pension debt.

Most cases aren’t contested, as people come to an agreement through their solicitors. That means you only need a consent order from the court for the pension scheme provider to be able to make the necessary changes. In these cases, the application for a financial court order is usually concluded quickly and the pension sharing order granted.

What happens next?

The exact amount of the pension credit won’t be known until the court order is finalised. When this happens, the amount to be transferred should be a percentage of the cash equivalent transfer value (CETV).

This is where it can get a bit confusing, as the CETV can change over time – even within the time it takes to finalise a divorce. It changes in value because of moves in the stock market, making it important when negotiating a pension share to work from the most up-to-date valuations. Someone will work all of that out for you.

However, what you need to know is that the ex-partner will always be entitled to a pension credit equal to the value of the pension debit. In other words, there’s no difference in what is lost and what is gained. But the pension won’t be shared as an exact 50/50 split. Normally, the aim is to ensure equal incomes in retirement, taking into account the other assets.

There are two ways a pension share can be received:

• The receiving party can become a member of their ex-spouse’s scheme in their own right (internal transfer)

• The receiving party can transfer the value to another pension arrangement in their own name (external transfer)

Whatever you decide to do, after the sharing order comes into effect, the receiving party owns the pension in their own right and can manage it how they want.

When is pension sharing a good idea?

Pension sharing might be a good option for you if:

• One party has high value pensions, compared to the other assets

• You’re close to retirement age and will find it difficult to build up similar pension benefits in a short time

• You’re thinking of remarrying soon, as the pension sharing order cannot be changed at a later date

• The divorcing couple is older. Under current rules, you can take benefits from the pension credit from when you’re 50, rather than waiting until your ex retires

• You’d like to be able to nominate potential beneficiaries of any death benefits if you were to die before taking retirement benefits

Overall, pension sharing offers a clean break and provides greater flexibility and choice to the divorcing couple. The involvement of the courts also assists in making sure there’s a fair settlement of marital assets.

However, pension sharing might not be the best option if keeping the family home is a key priority for you. Pension sharing means you might have to share other assets, including the home, meaning it might have to be sold. Also, it might not be the first choice for those with an adequate pension already. If you’re unsure what to do, contact us to discuss your requirements.

 It’s also important to remember not all pension can be shared:

• Occupational pension schemes (including AVCs) – Yes

• Personal pension schemes – Yes

• Stakeholder pension schemes – Yes

• S.32 policies – Yes

• Retirement annuity contracts – Yes

• Statutory pension schemes – Yes

• Free-standing AVCs – Yes

• Employer financed retirement benefit schemes – unapproved schemes – Yes

• Contracted-out benefits, State Second Pension (S2P) and State Earnings Related Pension (SERPS) – Yes

• Pensions in payment from any of the above – Yes

• Schemes in which the only benefits are equivalent pension benefits – No

• Basic state pension – No

• New state pension – No

• Pensions the member is receiving as a spouse, civil partner or dependant – No

• Pensions already subject to an earmarking or sharing order – No

Source: Pinington Law

Should you receive a Pension Sharing Order in a divorce settlement it would be advisable to seek professional financial advice as you may need to set up a “pension shell” for your pension settlement to be paid into.

The value of financial advice

Those who received financial advice in the 2001-2007 period had accumulated significantly more liquid financial assets and pension wealth than their unadvised equivalent peers by 2012-14.

‘The Value of Financial Advice’, produced by ILC-UK with the support of Royal London, analyses data from the largest representative survey of individual and household assets in Great Britain, the Wealth and Assets Survey. It finds that, even allowing for the fact that some groups are more likely to seek advice than others, those who received financial advice in the 2001-2007 period did better than an equivalent group who did not receive such advice, by 2012-14.

The report examines the impact of financial advice on two groups, the ‘affluent’ and the ‘just getting by’. The ‘affluent’ group is formed of a wealthier subset of people who are also more likely to have degrees, be part of a couple, and be homeowners. The ‘just getting by’ group is formed of a less wealthy subset who are more likely to have lower levels of educational attainment, be single, divorced or widowed and be renting.

‘The Value of Financial Advice’ finds that:

• The ‘affluent but advised’ accumulated on average £12,363 (or 17%) more in liquid financial assets than the affluent and non-advised group, and £30,882 (or 16%) more in pension wealth (total £43,245)

• The ‘just getting by but advised’ accumulated on average £14,036 (or 39%) more in liquid financial assets than the just getting by but non-advised group, and £25,859 (or 21%) more in pension wealth (total £39,895)

The report also finds that financial advice led to greater levels of saving and investment in the equity market:

• The ‘affluent but advised’ group were 6.7% more likely to save and 9.7% more likely to invest in the equity market than the equivalent non-advised group

• The ‘just getting by but advised’ group were 9.7% more likely to save and 10.8% more likely to invest in the equity market than the equivalent non-advised group

Those who had received advice in the 2001-2007 period also had more pension income than their peers by 2012-14:

• The ‘affluent but advised’ group earn £880 (or 16%) more per year than the equivalent non-advised group

• The ‘just getting by but advised’ group earn £713 (or 19%) more per year than the equivalent non-advised group

The report found that 9 in 10 people are satisfied with the advice received, with the clear majority deciding to go with their adviser's recommendation.

Despite the advantages of receiving advice, only 16.8% of people saw an adviser in the years 2012-2014. Indeed, ‘The Value of Financial Advice’ finds that even amongst those who took out an investment product in the last few years, around 40% didn’t take advice, rising to 78% of people who took out a personal pension.

After controlling for a range of factors, ‘The Value of Financial Advice’ concludes that the two most powerful driving forces of whether people sought advice was whether the individual trusts an Independent Financial Adviser to provide advice, and the individual’s level of financial capability. Therefore, the report makes a series of recommendations to raise demand for financial advice including:

• Using advice to support the auto-enrolled – duty on employers to ensure staff can access the best information and advice on their pensions

• Mandating default guidance for those seeking to access their pension savings – to ensure people can get crucial information in a complex marketplace and avoid worst outcomes

• Helping to create informed consumers through continued development and roll out the pensions dashboard

• Ensuring regulators continue to place emphasis on access to independent financial advice

Ben Franklin, Head of Economics of Ageing, ILC-UK said:

“Our results show that those who take advice are likely to accumulate more financial and pension wealth, supported by increased saving and investing in equity assets, while those in retirement are likely to have more income, particularly at older ages.

But the advice market is not working for everyone. A high proportion of people who take out investments and pensions do not use financial advice, while only a minority of the population has seen a financial adviser. Since advice has clear benefits for customers, it is a shame that more people do not use it. The clear challenge facing the industry, regulator and government is therefore to get more people through the “front door” in the first place.”

Source: A Research Report from ILC-UK

Public sector pensions

What is a public sector pension and do I have one?

Those who work in the public sector, typically, NHS staff, police, firefighters, teachers, lecturers, the armed forces and many other public sector workers are generally members of a defined benefit (or final salary) scheme. You may not be a public sector employee but still retain a defined benefit pension.

Defined benefit pensions vary from the average workplace pension and offer greater guarantees.

If you’re a public sector worker with a defined benefit pension scheme

A defined benefit (DB) pension doesn’t depend on a saved pot of money. How much you receive will depend on your pensionable service (how long you’ve been a member of the scheme, days, weeks months an years), your pensionable earnings (either your salary at retirement, or your average salary over the period of your membership) and the scheme’s accrual rate (the proportion of your salary you receive as pension for each year of service). A typical accrual rate might be 1/80, which means that if you spend 30 years in the scheme, your DB pension would pay you 30/80 (i.e. a quarter) of your final salary. So in this scenario, if you retired on a salary of £40,000 then you’d receive £15,000 a year for the rest of your life and a tax-free lump sum of £45,000, equivalent to three times your pension. (30/80 x 40 = 15 x 3 = 45)

In some schemes, taking a lump sum may reduce your annual income, but a lot of public sector pension schemes pay an automatic lump sum in addition to your annual income.

Can I transfer my pension under “pension freedoms”?

As far as the regulator (the FCA) is concerned there would be no good reason to transfer away from such a scheme, as the guarantees offered under a DB scheme are near impossible to replicate in a defined contribution (DC) environment. But it does depends on the kind of DB pension you have. Some schemes (such as the Local Government Pension Scheme or private-sector schemes) are known as funded schemes, because they are supported by a central fund. If you really want to, you can transfer out of these DB schemes. Your pension is then moved into a DC scheme, the size of which would be determined by your pension’s transfer value. But given the regulators beliefs you should consider the significant guarantees offered under a DB scheme. Be aware that this value may be significantly less than you would have received over your retirement if you had remained in the DB scheme – the advantage would be that you could access it in a variety of different ways, even all at once.

So what about NHS staff, firefighters, teachers, police etc?

Many public sector pensions are ‘unfunded’ schemes – that is, there is no central fund, and they are paid for only by the taxpayer, although members generally make a contributions also. The pensions of NHS staff, firefighters, teachers, the police and the armed forces all fall into this category. This means it’s not possible to transfer from this kind of pension into a DC scheme. So you may not have the same flexibility, but you do have the reassurance of a generous guaranteed income for your life and sometimes that of your spouse.

The cost of the State pension

What do I need to know about the state pension

The State Pension is a regular payment from the Government that you can claim when you reach your State Pension age.

Your State Pension is based on your National Insurance record. It takes into account the National Insurance you built up before the new State Pension was introduced in 2016, as well as contributions and credits since then. So not everyone will get the same amount.

The full amount of new State Pension is currently £168.60 a week – that’s just over £8,750 a year, but it’s important to check your State Pension online. It will tell you the amount you’re predicted to get, and the date you’ll reach State Pension age under the current rules.

However, this amount is probably insufficient for most people to live on and in real terms should only form the foundation for your retirement provisions.

National Insurance contributions.

You need to have paid national insurance contributions for at least 10 qualifying years, these years need to be qualifying years. A qualifying year means a year in which you earn over the Lower Earnings Limit as salary (dividends don't count). How much you receive will also depend on how many qualifying years you have. You need at least 35 qualifying years to qualify for the full amount.

If you check your state pension online it will also show you your National Insurance record, and whether you can improve it. You might be able to fill gaps by claiming National Insurance credits, or making voluntary National Insurance contributions.

You usually need to have 10 qualifying years on your National Insurance record to get the new State Pension, but you should check to see how your circumstances affect your National Insurance record.

What is the state pension?

The full amount of new State Pension is currently £168.60 a week – that’s just over £8,750 a year.

If you reached state pension age before 6 April 2016, you will receive the old state pension instead, which may be a different amount.

When can I start drawing my state pension?

The state pension age is currently 65 for both men and women, but may be different depending on when you were born. Answering the question ‘When will I get my state pension?’ means working it out from the year (and often the month) in which you were born. You can check your state pension age on the government’s website.

From April 2026 the state pension age will begin further increases to 66, and then to 67 by March 2028. It is expected to reach 68 by around 2044.

Work and the claim state pension?

Should you wish you can carry on working and earning once you’ve passed state pension age and began to draw your pension, but you’ll no longer pay National Insurance after this point. However state pension is still considered to be earned income, so could be subject to tax depending on how much other income you continue to earn. You may wish to talk to a financial adviser to make sure you’re not wasting too much of your state pension in tax. It may make sense to scale back your hours or find another solution.

Claiming the state pension from overseas

If you live abroad or are planning to move abroad and want to claim state pension, you’ll need to contact the International Pension Centre. You can then arrange for your state pension to be paid directly into a bank account, either located in the UK or in the country where you’re living now. You can choose to be paid every four or 13 weeks.

Should I delay taking my state pension?

If you choose not to take your state pension from the state pension age, the amount you’re entitled to will gradually rise. For every year you delay it, the amount you can receive will rise by around 5.8 per cent.

You might choose to do this if you were still working and didn’t want to lose state pension money in tax.

No you need to make more provision for your retirement than the State Pension offers you? - Then speak to a Financial Adviser and get some guidance.