Defined Benefit (DB) Pensions
A defined benefit (DB) pension, or final salary scheme, is a workplace pension which pays out an annual income, normally payable monthly, based on how much you are earning when you retire. The income you ultimately receive from your pension is a guaranteed, pre-agreed amount, hence the name 'defined benefit.'
DB pensions are most often provided by the public sector and government employers. Some large private sector employers offer them too. When you are a member of a DB or final salary pension scheme, your employer typically pays into a central fund on your behalf and is responsible for ensuring there’s enough money at the time you retire to pay your pension income. You can also contribute to the scheme throughout your working life, this may in fact be a requirement, depending on the scheme.
A DB pension provides valuable benefits, the biggest of which is something called ‘index-linking.’ This means that your pension income is guaranteed to rise each year so it can keep up with rising prices in the future. This protection is usually capped at a certain percentage per year. In some cases, it’s linked to the Retail Prices Index measure of inflation.
Advantages of DB schemes
- You will receive a secured income for life, which is likely to rise each year in line with inflation and your spouse / civil partner or other dependant may receive an income (subject to Income Tax) upon your death
- There is minimal paperwork needed to start the payment of benefits and no ongoing monitoring of the scheme is required once the first payment has been made
- DB schemes will place no personal investment risk on you
- Most DB schemes have a legal duty to provide a pension for a surviving widow / widower or dependant in the event of your death.
Disadvantages of DB schemes
- A DB scheme is rigid in its structure, you will get a set amount of money each month until you die therefore it cannot adapt if your needs change throughout retirement
- The payments of your scheme pension must be selected before taking any benefits and cannot be changed at a later date
- Many DB schemes have a pre-selected retirement age and taking benefits early can result in reduced pension benefits
- Any income you receive from a DB scheme will be subject to Income Tax at your highest marginal rate
- Any income you receive from a DB scheme may affect your entitlement to means tested state benefits
- Only your spouse / civil partner and children under the age of 23 (unless legally defined as a dependant if older) will usually be entitled to a reduced pension on your death. This will mean you will not be able to leave your pension benefits on death to any other party
- Any options (if offered by your scheme) to provide benefits on death must be selected at outset and will result in a lower initial pension payment.
Pension transfer
You can transfer a DB pension to a fixed-size pension pot of the kind found in defined contribution (DC) schemes. The general rule of thumb is that DB schemes offer very valuable guarantees, so it is usually not appropriate to transfer out unless you have valid reasons for doing so. Most people should remain in their current schemes but the answer for you will depend on many factors including your personal circumstances, the details of the pension you want to transfer and what it is you are looking to do and why.
If you’d be interested in discussing any aspect of DB pensions, or finding out more, please don’t hesitate to get in touch.
This document provides you with information on generic advantages and disadvantages of a defined benefit scheme. This article does not provide any advice on your personal circumstances or your actual defined benefit scheme. If you are unsure as to the most suitable option for your individual circumstances, you should seek financial advice.
Transferring out of a Defined Benefit Scheme is unlikely to be in the best interests of or be suitable for most people.