Employees and pensioners often rely heavily on their final salary pension benefits to provide an income in retirement.  The collapse of an employer can result in the loss of this valuable pension income and is rightly a worrying time for all involved.

Fortunately, two pension rescue schemes were established in recent years to provide a much needed financial safety-net should the worst happen.  Both schemes offer compensation to replace lost pension benefits, but they have different features.

Here is our simple guide to the Financial Assistance Scheme and the Pension Protection Fund.  This is recommended reading if you are a current or deferred member of an occupational defined benefits pension scheme, or if you are already in receipt of an income from this type of pension scheme.

The Financial Assistance Scheme

This pension rescue scheme provides help to people who have lost their pension benefits because their final salary pension scheme was wound-up without sufficient assets between 1st January 1997 and 5th April 2005.

The Financial Assistance Scheme (FAS) provides a benefit of 90% of the pension benefit you had built up at the time the wind-up of your pension scheme started.  This compensation is ‘revalued’ (increased by inflation as measured by the Retail Prices Index, subject to a cap of 5% a year) from the date of the wind-up until the date you become entitled for compensation under the scheme.  Any actual pension income you are still receiving from the pension scheme is deducted from the amount of compensation you get.

This rescue scheme is now administered by the Pension Protection Fund, so for more information on eligibility (including a list of pension schemes which have been assessed for protection under the FAS) you should visit their website at www.pensionprotectionfund.org.uk/FAS/Pages/Fas.aspx.

The Pension Protection Fund

This pension rescue scheme is in place for people who lose out on pension benefits from a defined benefits (final salary) pension scheme where the employer becomes insolvent and there are insufficient assets within the pension scheme to pay benefits.

The compensation limit varies depending on whether you have already reached the normal pension age of the scheme.  If you have already reached scheme pension age, the compensation is 100% of the pension benefits you should have received when the scheme went bust.

If you have not yet retired then compensation is limited to 90% once you get to the scheme retirement age.  However, this 90% compensation limit is subject to a cap which is recalculated each year.  As at April 2009 this cap equates to £28,742.69 at age 65. It is adjusted based on age when the compensation is actually paid.

Once compensation is in payment, future increases are linked to the Retail Prices Index (RPI) but these increases are capped at 2.5% a year. This means that the increases to your pension income through the compensation scheme could be less than any increases you might have received from the original pension scheme.

Who pays for all of this?

The Pension Protection Fund is funded by a levy on defined benefit pension schemes. For the 2010/11 tax year, the Pension Protection Fund aims to collect a total levy of £720 million from pension schemes.

The Financial Assistance Scheme is funded by the taxpayer.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.  You can follow him on Twitter @martinbamford.