Neil Homer – Does your final salary pension exceed the Lifetime Allowance

Thursday 22 February, 2018

Neil Homer, independent financial adviser and member of the Stafford financial planning team reviews your final salary pension scheme. 

This is particularly relevant for anyone who has worked for the same employer for many years on a relatively high salary as their pension savings could exceed the current Pension Lifetime Allowance.

Although the number of final salary pension schemes (defined benefit pension schemes) are being replaced by defined contribution schemes some larger employers still offer them.  The pension benefits you receive from a final salary pension scheme when you retire are normally calculated by considering your earnings and the length of time you have been in your employer’s pension scheme.

How to work out your final salary pensionable benefit – and will it exceed the pension Lifetime Allowance? 

If you are still working and will be due a final salary pension scheme when you retire you will have to estimate how many more years you expect to work before you can estimate your pension income.  The pension you will receive is likely to be based on your ‘final pensionable salary’ which is why they are often referred to as ‘salary related schemes.’  

This figure is normally worked out by checking your salary in the years just before you stop being an active member of your pension scheme.  However, all pension schemes define this differently so it is important to check your pension scheme details.  

Your pension scheme details will also advise you of the accrual rate.  Every pension scheme is different but this rate determines how fast you build up your pension benefits.  It is normally expressed as a fraction, for example 40/60ths.  The lower the bottom number the better the pension benefit you will be entitled to for an equivalent amount of pensionable service.  In most final salary pension schemes the pensionable benefit is worked out as follows: 

Length of pensionable service
 (normally years employed) 
----------------------------------------    x final pensionable salary
Accrual rate 
(the rate at which you build up pension benefits)

Case Study Final Salary Pension Example

For example if Ron ceased to be an active member of his pension scheme in March 2017 at the age of 55 and he is due to receive his final salary pension when he is aged 60 in March 2022 he can work out how much pensionable income he is entitled to as follows.

If Ron had worked at his company for forty years and his final pensionable salary when he left this employment in 2017 was 84,000 p.a. he will be entitled to a pension equal to 1/60th of his final pensionable salary for every year he worked (accrual rate).

Years worked when Ron was entitled to a pension – 40 years

Final Pensionable Salary £84,000 p.a.
Accural rate 1/60th
His preserved pension at the date he left the scheme – March 2017 (40years /60) x £84,000
= £56,000 p.a from the age of 60 (March 2022)

Ron’s preserved pension at date of leaving would be £56,000 but then it would be revalued between Date of leaving & retirement age.

What to do if your final salary pension exceeds the Lifetime Allowance?

In this example Ron will be entitled to £56,000 p.a pension income from March 2022.  However, the Lifetime Allowance is £1 million.  To calculate if pension savers have reached their Lifetime Allowance the annual income is multiplied by 20.  In Ron’s case his pension is currently worth £1,120,000.  

Neil Homer,  independent financial adviser Stafford and member of the Stafford financial planning team said:

 'This example shows how important it is for anyone with final salary pension schemes who are still working to estimate how much they think their pension plan will be worth when they retire.  In Ron’s case if he decides to take a lump sum now as he is entitled to at 55 years old he will be charged a rate of 55% on the £120,000 over the maximum Lifetime Allowance.  If he waits and takes all his pension as annual income when he is 60 because he is a higher rate tax payer he will pay a charge of 55% on the excess over £1 million.'

Neil Homer, pension adviser Stafford continued:

‘We recommend anyone in Ron’s position gets independent financial advice as soon as possible.  Similarly if you are working now and think you will exceed the pension Lifetime Allowance before you retire there are things you can do now.  For example you could retire early or after the age of 55 you could take a lump sum to prevent your total pension plan exceeding the £1m figure.  At Lonsdale Wealth Management our pension advisers are qualified to provide independent financial advice, having passed the Chartered Insurance Institute Diploma in Financial Planning & (RO8) Pensions Update Examination.  We can review your individual financial circumstances and recommend the best course of action.  We offer a free initial consultation at our St Albans, Ware, Stafford, Barnet, Leeds / Bradford and Harpenden offices.  For more information contact us.'

For more information review our Pension Planning information and read: Simon Hawker, independent financial adviser St Albans – Get advice if you are close to your pension Lifetime Allowance; Richard Porter, independent financial adviser St Albans – When to keep your defined benefit pension scheme; Richard Porter – Get pension advice at retirement; Deb Nolan independent financial adviser Leeds / Bradford – Will you have enough retirement income?

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