Defined contribution vs. defined benefit pensions
While the amount of money your defined contribution pension is worth on retirement depends on how much you’ve paid in and how your investments have performed, the value of a defined benefit pension is based on:
- How long you’ve worked for the company
- Your salary while working: sometimes your final salary, or sometimes an average of your salary over your career
- The accrual rate: the proportion of your salary you’ll get as an annual retirement income
Your employer is responsible for making sure there’s enough money in the scheme to pay you when you reach retirement. If your company gets into financial difficulty and can’t meet its pension commitments, the Pension Protection Fund (PPF) can cover your pension income, but you may receive a lower amount than you were promised by your employer.
Defined benefit pensions are increasingly rare, but you may have one if you’ve worked for a large company or a public sector organisation.
Moving a defined benefit pension
Private sector defined benefit pensions (and some public sector pensions) are funded, which means you can get a cash value for your pension and transfer this amount to another provider.
However, it’s important to understand that you’ll lose the retirement income promised by your employer. Instead, your pension money will be invested into a defined contribution plan, and the amount it’s worth on retirement will be based on how much you’ve contributed and how the investments have performed.
If you have a defined benefit pension that’s worth over £30,000, you have to consult with an independent financial adviser (IFA) before moving your pension.
If you’re in an ‘unfunded’ public sector pension scheme (for example an NHS pension, a teacher pension or a civil service pension), you won’t be able to move your pension. That’s because this type of pension uses the employer’s current income to pay pension benefits, rather than setting assets aside.
Withdrawing money from your defined benefit pension
Generally, your defined benefit pension pays you a retirement income, beginning at a certain age (60 or 65, for example). Your pension income increases each year to take into account the rising cost of living. When you die, a percentage of your pension can usually be paid to your partner or dependants.
Under new pension rules, you can take 25% of your pension as a tax-free lump sum when you reach 55 (57 from 2028). This is quite straightforward if you have a defined contribution pension, but when it comes to final salary pensions it can be complicated. Your pension provider will reduce the retirement income you’re due to receive based on how much you’ve withdrawn from your pension as a lump sum. Contact your pension provider for more details.
PensionBee combines your pensions into a new defined contribution pension plan that you can manage easily online. Find out more about PensionBee.
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
Last edited: 12-08-2021