What does an insurer ‘buy out’ of a final salary pension scheme mean?

I am in my early 60s and took my final salary pension when I was 55 years old in 2014.

Next January my company is winding up its pension fund and transferring all my benefits to Aviva.

Is this an opportunity for me to take my pension pot and use drawdown or will this not be allowed?

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Steve Webb replies: Your company pension is going through a process known as a ‘buy-out’.

A buy-out doesn’t change your rights or options under the scheme, but it may be helpful if I explain what happens when your pension rights are transferred to an insurance company in this way.

Under normal circumstances, a traditional ‘final salary’ pension scheme will build up a pot of money to pay all future pensions.

Most schemes are closed to new members and growing numbers are completely closed which means that no-one is building up any new pension rights.

But the scheme still needs to make sure that it has enough money to pay pensions this year, next year and for decades to come.

Until the final pound of pension is paid, the employer is responsible for making sure that the scheme has enough money.

One of the challenges for employers is that ‘making sure the scheme has enough money’ isn’t as easy as it sounds.

For example, what happens if we all start living longer?

The company may have thought that it had enough money in the pension scheme to pay future pensions. But if those pensions now have to be paid for longer, it will have to put extra money in.

Or what happens if the money invested in the pension scheme under-performs?

If some of the money in the fund is invested on the stock market there is always a risk that the value of those shares goes down (or doesn’t rise as quickly as forecast) and again that would leave a shortfall.

In all of these cases, there is a risk that a ‘deficit’ arises in the pension scheme and the employer then has to find extra money to deal with the hole in the pension scheme.

This creates uncertainty for the employer who might prefer to focus on running the business.

To get rid of this uncertainty and to get the pension scheme off its books, growing numbers of firms work with their pension scheme to reach a stage known as buy-out.

This is a point where there is enough money in the pension scheme to hand over to an insurance company in return for a promise by the insurer to pay all remaining pensions. The insurer takes on any remaining risk (for example, around how long people will live).

This can also be good news for the members of the scheme, whose pensions are now guaranteed by an insurance company, rather than depending on their employer (or former employer) still being in business for years to come.

Coming back to your situation, after the buy-out you are still entitled to exactly the same pension as you were before.

But instead of getting a payment out of your company pension fund you will get a payment from an insurance company. The amount you receive should be exactly the same and the rules remain the same.

However, what you cannot do is turn your regular final salary pension into a ‘drawdown pension’.

The fact that your pension is now being paid from the funds of an insurance company rather than a company pension scheme is unfortunately irrelevant.

Once you have started drawing a final salary pension you can no longer transfer out into a ‘pot of money’ type pension, and this is not affected by the fact that your scheme is going through a buy-out process.