Defined benefit pension schemes explained
A defined benefit (“DB”) scheme is a type of pension where income at retirement is pre-defined. Instead of saving up a pot of pension money, investing it and hoping for positive results, a DB pension offers guaranteed retirement income without investment risk. DB pensions are provided by employers. The employer effectively bears the investment risk on behalf of pension members.
Safeguarded Pension Assets
Safeguarded pensions offer valuable benefits – usually a protected element or guarantee. The protection or guarantee may be over income, fund value or lump sum entitlement.
UK safeguarded pensions cannot be changed without specialist advice. This rule was introduced as a rule by the UK financial regulator, the Financial Conduct Authority (FCA). Under FCA rules, all safeguarded pension assets with a value in excess of £30,000 will require advice from a qualified and regulated UK Pension Transfer Specialist adviser.
Defined Benefit Pensions
A defined benefit pension scheme is a form of ‘safeguarded’ pension asset. A DB scheme can be “final salary” or “career average”. A final salary scheme offers income linked to the salary a member earned upon leaving, while a career average scheme typically links to average salary over the final few years of employment.
Defined benefit schemes are provided by employers. The employer must manage their own scheme and account for all associated costs. DB benefits are valued by the pension income due at retirement, rather than an investment pot. Income benefits are calculated based upon member earnings and years’ service.
Every defined benefit scheme is different, because it has been ‘designed’ by the employer. Over the years, most employers have made significant adjustments to their DB pensions, usually to cut costs. DB scheme members have often collected pension benefits under different ‘sections’ – which can have distinctions over inflationary measures used, age for full retirement income or death benefits. Calculating exactly what you will receive as a retirement income from a DB scheme can be complex.
DB pension schemes offer valuable benefits
- Pre-defined lifetime income from scheme retirement age. The ability to take income earlier or later than scheme retirement age, subject to scheme factors and calculations
- A Pension Commencement Lump Sum (PCLS), which may be automatic or generated by commutation, by sacrificing a portion of income
- Structured lifetime death benefits available to a spouse or other qualifying financial dependent, which can include children to age 18/21 or in some cases, long-term financially dependent partners
- Income benefits linked to inflation, while this is not available under all schemes, it is a common inclusion or option
- No explicit costs, a scheme such as this is the responsibility of your former employer, your benefits are not affected by explicit charges
- Protection under the Pension Protection Fund (PPF), most schemes are qualifying members of the PPF, therefore it is important you understand that in the event a scheme becomes insolvent, it may qualify for protection for its members. Visit www.ppf.co.uk
Transferring a final salary or career average pension
A DB scheme offers a pre-structured lifetime income in retirement. This is suitable for most people, offering an excellent healthy ‘backbone’ to long-term financial security. Many choose to keep their DB scheme income in place, complimenting this with other sources of flexible income. However, if you’re considering alternative planning options, you may explore the pension transfer option and request a Cash Equivalent Transfer Value (CETV) from your scheme. Use our free CETV calculator online to see what your DB pension could be worth.
UK Government Pensions & Unfunded Schemes
Most defined benefit pension schemes can be transferred. However, some years ago the UK government blocked all transfers out of ‘unfunded’ schemes. This does not affect any private DB pensions, provided by private companies, but does affect UK government pensions.
In the UK, government pensions such as the Teachers, Armed Forces, Police and NHS pensions are not ‘funded’. This means there isn’t a big pot of money ready to pay out retirement incomes and offer transfer values. Instead, pension income is paid out of the UK budget – effectively from active taxpayers. Due to the demand for pension transfers, and the cost required to pay CETVs for those wanting to transfer-out, the UK government put a temporary stop to transfers out from unfunded government schemes. This continues today, and we have seen no indication of changes to the rule. If you’re unsure of whether your pension scheme can offer a CETV, contact them using our free toolkit, or drop us a quick message.
Taking pension specialist advice
A DB scheme valued in excess of £30,000 requires FCA regulated advice from a UK pension transfer specialist. We operate a panel of qualified and regulated UK specialists and can introduce you to the right person. All initial consultation ‘chats’ are free of charge and intend to explore only whether professional advice could be right for you.
Before you take advice, use our pension toolkit to research your DB benefits. When you get your pension information back, use our pension jargon buster to help understand the answers you get from your pension scheme.