Defined benefit pension, which are also called final-salary or salary-related pensions, represent a different kind of retirement plan. Backed by certain qualifying employers, they enable both them and their employees to also benefit from substantial tax incentives. Well regulated, all such schemes offer pensions stability by complying with legal requirements. The regulations are currently enforced in amendments under the Pensions Acts 2004, 2007 and 2008 and are overseen by the Pensions Regulator.
Defined benefit pension plans entitle the holder to receive certain benefits when they retire. Age, salary received and the amount of time spent paying into them are all factors that will determine how much they pay out.
Employees themselves may be required to contribute to the plan for a qualifying vesting period before being eligible for full retirement benefits. Along with employers and their employees, the government also makes a contribution to the scheme.
There is a requirement that each party pays a minimum amount on an ongoing basis:
• The Government: 0.2% of ‘qualifying earnings’, rising to 1% by 2018
• Employers: 1% of ‘qualifying earnings’, rising to 3% by 2018
• Employees 0.8% of ‘qualifying earnings’, rising to 4% by 2018
A specific formula is currently in place to calculate the amount of retirement benefit that each participant in the scheme will receive. This is typically expressed as 1/60 or 1/80.
Bob works for forty years at the same company, with a final salary of £30,000. The accrual rate of the company is 1/60th. His annual pension based on this amount would be 1/60 x 40 x £30,000 = £20,000.
Obviously, if Bob decides to exit the scheme earlier, then the amount received will be less.
Many schemes of this nature afford holders a choice of how to receive their pension.
Members can choose to receive a tax-free lump sum upon retirement. This can be no more than 25% of the total value of their pension pot. Tax is payable on remaining payments. Before choosing to opt for this, holders would be well advised also to calculate how it would affect their income over the life of their pension. As of March 2014, holders with a total pension pot of £30,000 or less can opt to withdraw the entire amount as a lump sum, with one quarter being tax-free.
A Single Life Annuity
This option provides the holder with a fixed monthly payment until death.
Qualified Joint and Survivor Annuity
This also provides monthly payment, but the remaining payment, or at least 50% of it, is passed on to the surviving spouse when the pension holder dies. Additionally, a dependent child, civil partner or spouse might also have an entitlement to a lump sum under the terms of this agreement.
Before making a decision regarding their defined benefit pensions , members of the scheme should consider their long-term pensions security. It is a good idea to seek advice from a professional organisation, such as Aon Hewitt, before going ahead.
Providing a comfortable retirement income, defined benefit pensions, together with any social security benefits that are due, can amount to around 70% of a person’s pre-retirement income. Additionally, because defined benefit pensions are not reliant on the performance of an investment, it is typically possible for holders to accurately predict what their retirement income would be.
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