Overview
A Final Salary Scheme is a form of occupational pension scheme in which the retirement benefits are calculated based on the employee’s final salary at the point of retirement, or the highest salary they’ve earned during a specified period of their employment. This is a type of defined-benefit pension plan, meaning the benefits paid out during retirement are pre-determined and based on specific formulas involving the last salary and years of service.
Examples
- Tom’s Retirement from Bell Corporation: Tom has worked for Bell Corporation for 30 years. His final salary before retiring is $100,000. According to the company’s Final Salary Scheme, he receives an annual pension of 50% of his final salary, which is $50,000.
- Jane’s Pension from Delta Enterprises: Jane retires after 25 years of service with Delta Enterprises and her final salary is $80,000. The Final Salary Scheme calculates her annual pension at a rate of 2% of the final salary per year of service. Thus, Jane receives 50% of $80,000, which is $40,000 annually.
Frequently Asked Questions (FAQs)
What is a Final Salary Scheme?
A Final Salary Scheme is a type of defined-benefit pension plan where the retirement benefits are calculated based on the employee’s salary at or near the end of their employment.
Is the Final Salary Scheme same as the Defined-Benefit Pension Scheme?
Yes, a Final Salary Scheme is a type of defined-benefit pension scheme, but not all defined-benefit schemes are final salary schemes. Defined benefit can also include other formulas for determining pension benefits such as career-average earnings.
How is the pension calculated in a Final Salary Scheme?
The pension is typically calculated based on a specified percentage of the final salary multiplied by the number of years of service. For example, 1.5% of the final salary for each year of service.
Are Final Salary Schemes still common?
Final Salary Schemes are becoming less common in favor of defined contribution schemes due to the high financial risks and cost requirements for employers.
Who bears the investment risk in a Final Salary Scheme?
In a Final Salary Scheme, the employer usually bears the investment risk, as they guarantee a specified benefit amount upon retirement.
Can benefits under Final Salary Schemes change?
While the formula for calculating benefits remains the same, the ultimate pension amount can change if the scheme incorporates salary changes or additional years of service after initial calculations.
Is the Final Salary Scheme favorable for employees?
Yes, Final Salary Schemes are typically very favorable for employees because they offer predictable and often generous retirement benefits.
Related Terms
- Defined-Benefit Pension Scheme: A pension scheme where retirement benefits are calculated based on a set formula which can include salary history, duration of employment, and age.
- Defined Contribution Plan: A retirement plan where the employer, employee, or both make contributions on a regular basis, and the final benefits depend on the investment performance of these contributions.
- Occupational Pension Scheme: Also known as a workplace pension, this is a pension scheme provided and often funded (at least in part) by an employer.
Online Resources
- Investopedia on Final Salary Scheme
- The Pensions Regulator: Defined benefit (DB) schemes
- Gov.uk Workplace and Personal Pensions
Suggested Books for Further Studies
- “Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back Under Your Control” by M. Barton Waring
- “The Future of Pension Management: Integrating Design, Governance, and Investing” by Keith P. Ambachtsheer
- “Pension Ponzi: How Public Sector Unions are Bankrupting Canada’s Health Care, Education, and Your Retirement” by Bill Tufts and Lee Fairbanks
Accounting Basics: “Final Salary Scheme” Fundamentals Quiz
Thank you for learning about Final Salary Schemes with us and taking on the challenge of our quiz. Continue enhancing your financial literacy and understanding of accounting terms.
