Final Salary vs. Money Purchase Schemes

Money in the UK

Traditionally, the pension scheme for most companies has been the Final Salary Scheme, it offered the best, safest return for employees, and rewarded those who spent their entire careers with one company, building up their pension to the highest possible level. For many employers, however, Final Salary pensions have become too expensive to operate, and they now offer alternative schemes to their employees.

One such scheme is the Money Purchase Scheme, which is, in general, a lot cheaper for a company to run. In a Money Purchase Scheme the employees pay money into a retirement fund through the company which is then invested in order to get a higher return. When the employee retires, the retirement fund is used to buy an annuity – which is a type of financial product that will secure the income of the employee for the rest of their life.

The size of the pension, therefore, unlike other schemes, relies on the success of the retirement funds investments, and also on the annuity rates that are available at the time of retirement, the employee makes no guarantee as to how much the fund will pay out, and therefore the system is a lot riskier and less attractive for employees, but more attractive for the employers.

Some businesses offer a mixture when it comes to pensions, offering different levels of risk for their employees. This generally involves a kind of reduced Final Salary Scheme, coupled with stock options or investment funds and the employee can choose how much risk they are willing to take. Obviously, there is a chance that such funds can perform extremely well and pay a much higher pension that would have been the case through a standard Final Salary Scheme.

The system works fine in a rising stock market, as the value of the funds will be high, in recent years, however, with the stock market falling and particularly at the moment, cashing in these schemes can result in a much poorer retirement than expected. If you have such a scheme at the moment and are approaching retirement, it may well be best to wait for a few months for the world economy to improve, as the value of your fund in a few months may be much higher than it’s value now.

A recent study has found that in general employers contribute much less into money purchase schemes than they do into final salary schemes and, therefore, money purchase schemes may well need supporting with extra income when it comes to retirement. For this it is important to consider the value of a private pension through a company such as Legal and General. Private pensions are less prone to the turmoils of the world economy, particularly in comparison to pensions involving stock options, and may well provide better for your retirement than a scheme held through your employer or various employers. They are definitely worth looking into.