Defined benefit pension schemes explained

A defined benefit (DB) pension scheme is one where the amount you’re paid is based on how many years you’ve worked for your employer and the salary you’ve earned.

How defined benefit pensions work

Defined benefit pensions pay out a secure income for life which increases each year. You may have one if you’ve worked for a large employer or in the public sector.

Your employer contributes to the scheme and is responsible for ensuring there’s enough money at the time you retire to pay your pension income. You can contribute to the scheme too.

They usually continue to pay a pension to your spouse, civil partner or dependants when you die.

Your pension income

Your income is based on:

Pensionable service The number of years you’ve been a member of the scheme
Pensionable earnings This could be your salary at retirement (‘final salary’), salary averaged over a career (‘career average’) or another formula
Accrual rate The proportion of your earnings you’ll get as a pension for each year in the scheme (commonly 1/60th or 1/80th)

How to work out your pension income

You pension income is usually calculated like this:

  • years in scheme
  • multiplied by pensionable earnings
  • divided by accrual rate

For example, if:

  • you were in a DB pension scheme for 10 years
  • you retire at 65 on a salary of £24,000 a year
  • your scheme has an accrual rate of 1/60th

This would give you a pension of:

10 (years) multiplied by £24,000 (salary)

divided by 60 (accrual rate)

= £4,000 a year (less if you take any tax free cash lump sum).

Checking your pension income

Your latest pension statement will give you 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 usually show your pension based on:

  • your current salary
  • how long you’ve been in the scheme
  • what your pension might be if you stay in the scheme until normal retirement age (usually 65)

If you’ve left the scheme, you’ll still get a statement every year showing how much your pension is worth.

In most cases your pension will increase by a set amount each year up until retirement age.

If your scheme allows you to take part of your pension as a tax-free lump sum, make sure you know whether your statement shows the amount you’ll get before or after taking it.

Also, don’t forget that your actual pension income will be taxable.

When you can take your pension

Most defined benefit schemes have a normal retirement age of 65. This is usually when your employer stops contributing to your pension and your pension starts to be paid.

Depending on your scheme, you may be able to take your pension from the age of 55, but this can reduce the amount you get. It’s also possible to take your pension without retiring.

You may also be able to defer taking your pension. This might mean you get a higher income when you do take it. Check 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) for life.

When you die, it may continue to be paid to your spouse, civil partner 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 you’ll have to pay Income Tax on the rest.

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

  • the total value of all your pension savings is less than £30,000.
  • your pension is worth less than £10,000, regardless of how much your other pension savings are. You can do this for up to three different pensions.

Transferring your defined benefit pension

If you’re in a private sector defined benefit pension scheme or a funded public sector scheme, you can transfer to a defined contribution pension as long as you’re not already taking your pension.

Defined contribution pensions can be accessed flexibly from age 55 so this may seem like an attractive option.

But in most cases you‘ll be worse off in a defined contribution pension, so it’s rarely a good idea to transfer, even if your employer offers you incentives to switch.

If your pension savings are £30,000 or more, you’re required by law to take advice from a financial adviser who is independent from your defined benefit scheme before transferring.

If you’re in an unfunded defined benefit pension scheme (these are mainly public sector schemes), you won’t be able to transfer to a defined contribution pension scheme, but you’ll still be able to transfer to another defined benefit pension scheme.

Protecting your defined benefit pension

Defined benefit schemes are protected by the Pension Protection Fund. This pays some compensation to scheme members if employers become insolvent and the scheme doesn’t have enough funds to pay their benefits.

The compensation may not be the full amount and the level of protection depends on whether you’re:

  • already drawing benefits
  • still contributing to the scheme
  • a deferred member who has left the scheme but has built up an entitlement

Tracing lost pensions

If you can’t find the details for an old defined benefit pension scheme, you can use the Pension Tracing Service to find it.