Final salary pensions work differently to defined contribution pensions. The coronavirus crisis has seen several members of the public face financial hardships, but in the longer term will your final salary pension be impacted by coronavirus?
What is the final salary pension?
A final salary pension is a pension scheme which promises to pay out an income based on how much you earn when you retire.
Unlike defined contribution pensions, the amount you receive at retirement is guaranteed and will be paid directly to you, meaning you will not have to use your pension pot to decide what to do next.
Final salary pensions, also called defined benefit, pay a guaranteed income for life when you retire.
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How much will your final salary pension be?
A final salary pension depends on your salary, the number of years you have worked and the accrual rate on the scheme.
The accrual rate is using 1/60, 1/80 or 1/100 of the final salary amount.
You can check your accrual rate with your employer.
Will final salary pensions be impacted by the coronavirus pandemic?
If your employer remains in business, your pension should be safe.
For workers in the public sector, such as teachers, firefighters and nurses, final salary pensions will be unaffected and remain safe.
Most public sector schemes are funding through taxation which means movements in stock markets or business collapses will have no effect on whether your final salary pension will be paid.
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However, if you work in the private sector, your pension promise is backed by a fund which has been set aside to pay your pension.
This money is overseen by a group of trustees who are entrusted with the responsibility to make decisions about how best to invest the money and decide how the scheme is run.
Your scheme will undergo a review and valuation process every three years where the trustees evaluate all pensions which are due to be paid in the coming decades and compare this with the returns they expect to see on that money as it sits in the fund.
If there is a deficit, the Pensions Regulator requires the scheme to devise a plan to handle this which typically involves the employer making additional payments over a set number of years.
With the onset of the coronavirus crisis, some schemes where there was heavy investment in shares, the recent falls in the stock market could mean the asset values have dropped.
Low-interest rates are disruptive to final salary pensions as returns are low and therefore deficits are larger.
But given the financial hardships resulting from the crisis, employers may struggle to provide the extra money to make the additional payments.
The Pensions Regulator is permitting employers to defer making payments into schemes for a three-month period if necessary.
If the coronavirus crisis continues beyond that point, it should be possible to make up the losses.
However, if the economy takes a long-term dip, then a combination of increased deficits and reduced contributions could cause issues for final salary schemes.
The biggest problem would be if your employer goes out of business, which could mean you will see the impact, particularly if the pension scheme did not have enough money set aside to pay all of its future pensions at the time of the collapse.
If the pension scheme was significantly short, it would be likely to end up in the “lifeboat” Pension Protection Fund, assuming your scheme was registered in the UK.
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