Defined Benefit pension schemes

A secure income for life A Defined Benefit (DB) pension scheme is one where the amount paid to you is set using a formula based on how many years you’ve worked for your employer and the salary you’ve earned rather than the value of your investments. If you work or have worked for a large employer or in the public sector, you may have a DB pension.

How Defined Benefit pensions work

Defined Benefit (DB) pensions pay out a secure income for life which increases each year. They also usually pay a pension to your spouse or registered civil partner and/or your dependants when you die.

The pension income they pay is based on:
  • The number of years you’ve been a member of the scheme – known as ‘pensionable service’
  • Your pensionable earnings – this could be your salary at retirement (known as ‘final salary’), or salary averaged over a career (‘career average’), or some other formula
  • The proportion of those earnings you receive as a pension for each year of membership – this is called the ‘accrual rate’, and some commonly used rates are 1/60th or 1/80th of your pensionable earnings for each year of pensionable service

These schemes are run by trustees who look after the interests of the scheme’s members. Your employer contributes to the scheme and is responsible for ensuring there is enough money at the time you retire to pay your pension income.

How much will my income be?

Check your latest pension statement to get an idea of how much your pension income may be. If you haven’t got one, ask your pension administrator to send you one.

Statements vary from one scheme to another but they usually show your pension based on your current salary, how long you’ve been in the scheme and what your pension might be if you stay in the scheme until the scheme’s normal retirement age (usually 65).

If you’ve left the scheme, you’ll still receive a statement every year showing how much your pension is worth. In most cases this pension will increase by a set amount each year up until retirement age. Contact your pension administrator if you’re not receiving your annual statement.

When you take your pension, you can usually choose to take up to 25% of the value of your pension as a taxfree lump sum. With most schemes, your pension income is reduced if you take this tax-free cash. The more you take, the lower your income. But some schemes, particularly public sector pension schemes, pay a tax-free lump sum automatically and in addition to the pension income.

Make sure you understand whether the pension shown on your statement is the amount you’ll get before or after taking a tax-free lump sum. Also, don’t forget that your actual pension income will be taxable.

When can I take my Defined Benefit pension?

Most DB schemes have a normal retirement age of 65. This is usually the age at which your employer stops paying contributions to your pension and when your pension starts to be paid. If your scheme allows, you may be able to take your pension earlier (from the age of 55) but this can reduce the amount you get quite considerably. It’s possible to take your pension without retiring.

Again, depending on your scheme, you may be able to defer taking your pension, and this might mean you get a higher income when you do take it. Check with your scheme for details.

Once you pension starts to be paid, it will increase each year by a set amount – your scheme rules will tell you by how much. It will continue to be paid for life. When you die, a pension may continue to be paid to your spouse, civil partner and/or dependants. This is usually a fixed percentage (for example, 50%) of your pension income at the date of your death.

Taking your pension as a lump sum

You may be able to take your whole pension as a cash lump sum. If you do this, up to 25% of the sum will be tax-free and the rest will be subject to Income Tax.

You can do this from age 55 (or earlier if you’re seriously ill) and in the following circumstances:

• You can take the whole of your pension as cash if the total value of all your pension savings is less than £30,000

• You can take your pension as cash if it’s worth less than £10,000, regardless of how much your other pension savings are. You can do this for up to three different pensions

When you take your pension, you can usually choose to take up to a 25% of the value of your pension as a tax-free lump sum.

Transferring your Defined Benefit pension

If you’re in a private sector DB pension scheme or a funded public sector scheme, you can transfer to a Defined Contribution (DC) pension as long as you’re not already taking your pension. DC pensions can be accessed flexibly from age 55, so this may seem like an attractive option.

However, in most cases you may be worse off in a DC pension, and for this reason it’s rarely a good idea to transfer even if your employer offers incentives for you to switch.

If you’re in an unfunded DB pension scheme (these are mainly public sector pension schemes), you will not be able to transfer to a DC pension scheme but will still be able to transfer to another DB pension scheme.

Protection for your Defined Benefit pension

DB schemes are protected by the Pension Protection Fund. This pays some compensation to scheme members whose employers become insolvent and where the scheme doesn’t have enough funds to pay members’ benefits. The compensation may not be the full amount, and the level of protection varies between members already drawing benefits, those who are still contributing to the scheme and deferred members who have left the scheme but have built up an entitlement.

Is it time to review your retirement plans?

These reforms present people with an exciting opportunity to take control of their pensions like never before, but the reforms highlight the need to obtain professional financial advice to consider your overall position. Although it may seem counter-intuitive, accessing your pension fund in many cases may be the last asset you call on, given the tax-efficiencies. To review your situation, please call us or use the contact form by clicking here – we look forward to hearing from you.

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