What is a defined benefit pension?

A defined benefit pension is a workplace pension scheme that gives you a guaranteed, regular income when you retire. 

In this guide, we explain how defined benefit pensions work, how your income is calculated, and when you can take it. We’ll also look at the key pros and cons, and when a pension transfer might be possible.

 

How do defined benefit pensions work? 

Defined benefit pensions are set up by your employer, and they normally make most or all of the contributions. They are responsible for making sure there’s enough money in the scheme to provide you with a regular income throughout your retirement. 

How much you’ll get from your defined benefit pension depends on things such as your salary and how long you’ve worked for your employer. 
When you approach retirement, your pension provider will tell you how much you’ll get each year. You’ll receive regular payments, which typically rise with inflation.

If you have a pension insured by Canada Life, you can find out more about your pension here.

Who gets a defined benefit pension?

You’ll only have a defined benefit pension if your employer offers one. While defined benefit pension schemes remain common in the public sector, they’re now rare in the private sector because they can be costly for employers to run. Some large, established companies still offer them, but most private sector schemes have closed to new members as employers move away from this type of pension. 

Not sure if you have a defined benefit pension? You can use MoneyHelper’s free tool to find out your pension type.

How your defined benefit pension is calculated

How much you’ll get from your defined benefit pension depends on your pension scheme’s rules. Typically, the calculation includes three main factors:

• Pensionable salary: The elements of your pay that count towards your pension. For example, this could include overtime but exclude travel expenses.
• Years of service: How long you’ve worked for your employer.
• Accrual rate: The fraction of your pensionable salary that you’ll get as retirement income. The higher your rate, the faster you’ll build up pension benefits.

The exact calculation will depend on which type of defined benefit pension you have. Your pension provider will make the calculation and tell you how much you’ll receive each year when you retire.

Learn more about how defined benefit income is calculated.

Types of defined benefit pensions

There are two types of defined benefit pension schemes: final salary and career average. The type of defined benefit pension will determine how your pension is calculated.

• Final salary pensions are based on your salary at the point when you retire or leave the pension scheme.
• Career Average Revalued Earnings (CARE) pensions take an average of your salary for the period that you’ve been part of the pension scheme.

What is the difference between a defined benefit pension and a defined contribution pension?

A defined benefit pension and a defined contribution pension both help you save for retirement, but they work differently.

Defined benefit pensions

Your employer sets up your defined benefit pension, which provides a guaranteed income based on your salary and your length of service.

Defined contribution pensions

Either you or your employer can set up a defined contribution pension, with both of you normally making contributions. Your pension provider invests this money to create your pension pot. Your provider will invest in a default fund, however many schemes allow you to choose from other funds or strategies instead.

The size of your pot depends on how much is paid in, how well the investments perform, and how you decide to take the money (for example, as a lump sum or regular payments).

Defined contribution pensions are more common than defined benefit pensions, but you may have both types if you’ve worked for different employers during your career.

Learn more about the difference between a defined benefit pension and a defined contribution pension.

What are the benefits of a defined benefit pension?

• Simplicity and stability
  Your employer or insurer handles the investments, so you don’t need to make complex decisions about investing.
• Lifelong income
  You’ll receive a guaranteed, regular income – no matter how long your retirement lasts or what happens in the financial markets.
• Inflation protection
  With many schemes, your retirement income will automatically increase in line with prices, preserving your purchasing power.
• Support for loved ones (depending on your policy)
  Your partner or dependents will typically receive a percentage of your pension after your death, depending on your scheme.

Check your benefits
Your scheme will determine which of these benefits apply to you – your financial adviser or pension provider can confirm the details.

Potential limitations of defined benefit pensions

• Less flexible drawdown options
  Your income is fixed so you won’t be able to change the amount or frequency of your payments, even if your circumstances change.
• No control over investments
  You don’t choose where to invest your pension, your employer (or their partner) does – so you may miss out on opportunities to grow your money quicker.
• Taking benefits early usually reduces income
  If you need to take your pension before the scheme’s normal retirement age, you could be penalised with a reduction in your retirement income.
• Employer risk
  If your employer fails, the Pension Protection Fund will step in to provide compensation. But the amount you get may be less than the amount your scheme would have paid. If management of your pension has been taken over by an insurer, your pension income is protected under the Financial Services Compensation Scheme (FSCS). 
• Limited inheritance potential
  While many schemes offer some support to loved ones after your death, you can’t build up a pot of unspent funds to pass onto beneficiaries.  

When can I take my defined benefit pension? 

You can take your defined benefit pension when you reach the ‘normal retirement age’ set by your scheme. This age is decided by the scheme and can differ from your State Pension age, which is set separately by the government.

You may be able to take your pension earlier if your scheme allows it – but this will likely reduce the amount of retirement income you get.

From age 55, you may be able to take part of your pension as a tax-free lump sum, depending on your scheme’s rules. The remainder of your pension will be subject to income tax.

Can you have multiple pensions at the same time?

You can have at the same time, and if you’ve had different jobs throughout your career, you will likely have been part of different pension schemes. So, you may have a mix of defined benefit and defined contribution pensions, as well as any you set up yourself (known as personal pensions).

Lost track of your pensions?
You can use the Government’s free tool to find contact details for your pensions.

Defined benefit pension transfers

It is possible to transfer your defined benefit pension to a defined contribution pension, but only in some cases.

You cannot transfer your defined benefit pension if:

• You have already started taking your pension
• You’re part of certain public sector schemes, such as teachers’ or NHS pension schemes.

Transferring your defined benefit pension is a big financial decision. It's important to understand the process and what you might be giving up by leaving a scheme that provides guaranteed income for life.

Learn more about defined benefit pension transfers.

 

Learn more about defined benefit pensions