Final Salary Scheme Pensions
Final salary scheme pensions, also known as defined benefit schemes, provide a promised level of retirement income. This was based on how long you were a member of the scheme and your level of earnings at the time. These often include GMP.
You will only have GMP if you were in such a scheme before 1997, and some schemes don’t have GMP. You would also have to have been a member of what is/was called a contracted out scheme.
So if you were a member of such a scheme, rather than accruing benefits under the second state pension pension, which was known as the State Earnings Related Pension Scheme (or SERPS for short), the scheme would promise to give you a pension that contained GMP instead.
The same GMP rules applied, such as spouses pensions, and increases etc.
GMP in a Final Salary Scheme
It is unusual (but not impossible) to find a final salary scheme that just contains GMP. They are usually made up of GMP and income over and above the GMP – or the “excess” as we call it.
Different rules could apply to the different elements.
Let’s give an example of how a final salary scheme with GMP could work.
Suppose Mr Jones was a member of a final salary scheme between March 1987 and May 1992, and he left aged 35. At the point of leaving he had a promised pension of £700 per year pension.
This pension was not frozen, it was preserved. The law requires that it increases from the point of leaving and retirement age, which for this scheme was say 65.
His pension would be made up of three elements, Pre 88 and Post 88 GMP, and benefits over and above the GMP – the “Excess” as it is called. The table shows examples of how much these different elements could be, and how they could increase.
| Income Type | Amount 1992 £ | Increases to age 65 | Amount at age 65 |
|---|---|---|---|
| Pre 88 GMP | £100 | 7.5% per year | £814 |
| Post 88 GMP | £200 | 7.5% per year | £1,628 |
| Excess | £400 | Inflation with a maximum 5% per year | £828 |
Impact of GMP
As you can see in this instance the two types of GMP for this scheme, increase by 7.5% per year (fixed rate revaluation as it is called – see GMP Rules for more details). This level of increase means that the Guaranteed Minimum Pension increases by eight-fold between leaving and age 65.
The “excess” only increases by inflation, with a yearly cap of 5% per year. This means that it only doubles between leaving the scheme and retiring.
The key point is that when he left the scheme he had £300 per year of GMP and £400 of Excess pension income, but at retirement he had almost £2,400 of GMP and only £800 of Excess.
This can cause issues if you want to retire early, and/or can restrict the amount of tax-free cash available. See GMP Disadvantages for more details. But it also shows just how valuable Guaranteed Minimum Pension can be, and how valuable old final salary scheme pensions are, see GMP Advantages for more details.
Final Salary Schemes & GMP Rules
If you have a final salary scheme pension with Guaranteed Minimum Pension, then the GMP element has to follow GMP Rules such as:
- Provide a widows pension of at least 50%
- Increase each year between leaving and retirement
- Ensure the amount payable at 60 for a woman, or 65 for a man ,is at least the amount of promised GMP
- Post 88 GMP must, once it starts to be paid, increase by at least inflation (with a maximum of 3%)
- Ensure that the GMP is not used to pay a tax-free lump sum
GMP Problems & Final Salary Schemes
There is no doubt that a pension with Guaranteed Minimum Pension is very valuable. But it can cause problems with early retirement and access to tax-free cash.
It is possible to give up a final salary scheme pension with GMP, and transfer it to lose the GMP requirements. This would usually not be in your best interests, as it would mean giving up guaranteed benefits.
But, there are some instances when this can be beneficial, especially if you have medical problems and you are:
- Single
- Want to retire early
- Want access to more tax-free cash or bigger lump sum
- When you want better death benefits
For more information on transferring a final salary scheme pension with GMP see GMP and Final Salary Scheme Transfer.
If you have a pension with GMP and want advice, or have a question, or just want to have a chat about it with a UK Qualified Independent Financial Adviser, then phone now on 01793 686393 or contact us online.