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Wednesday, 11 December, 2002, 08:59 GMT
Pensions explained: Final salary schemes
Final salary schemes
As part of its understanding pensions series, BBC News Online provides an introduction to final salary schemes.
What are they?

Final salary schemes have traditionally been seen as the best type of pension a worker can get.

They guarantee to pay a retirement income based on a percentage of your salary every year for the rest of your life.

The amount you get depends on how long you have spent working for your employer and how much you were earning at the time you gave up work - your final salary.

The sum is typically between a half and a third of your salary.

However, Inland Revenue rules allow members to build up a pension equivalent to two-thirds their final salary.

What are defined benefit schemes?

Final salary schemes are sometimes called "defined benefit" schemes.

This is because the benefits are set out by the employer before a member joins the scheme.

Aren't they in trouble?

Final salary schemes have been big news over the last year.

This is because a growing number of employers are saying they are too expensive to keep open.

More than eight million people are still members of final salary schemes.

But the next generation of workers are unlikely to benefit from them, as an increasing number of firms are closing them to new entrants.

Why are they closing?

The stock market falls of recent years have meant that the total assets held by many company schemes have shrunk.

If assets fall below liabilities then employers are duty bound to prop up ailing final salary schemes in order to ensure that members are paid their benefits in full.

In a falling market, from an employers perspective, final salary schemes have the potential to become very expensive to run.

A new accounting standard, called FRS17, has also been blamed.

FRS17 means employers will have to be more transparent about pension fund liabilities within company accounts.

The biggest gripe, however, from employers is the 10% tax on dividends earned by pension schemes, which was imposed by the chancellor shortly after the present government was elected in 1997.

Dividends play an important part in the long-term health of pension schemes. Any tax on them increases the possibility that the scheme will not have sufficient assets to meet liabilities.

As a result, over recent years, some of the country's biggest employers have abandoned final salary schemes in favour of cheaper "money purchase schemes".

Are final salary schemes really that good?

Despite measures which were put in place following the Maxwell scandal of the early 1990s, final salary schemes are not completely safe.

A number of recent cases have highlighted problems which can arise when an employer decides to wind-up its scheme.

Under current wind-up rules, the bulk of the pension fund is given to existing pensioners, and people who have taken early retirement.

Employees who have not yet retired can be left with virtually nothing, after decades of paying contributions.

The government is expected to address this issue within its forthcoming Green Paper on pensions on 17 December.

Where can I get further information?

Government plans

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