Defined Benefit pensions pay out a secure income for life based on the number of years you’ve worked for your employer and the salary you’ve earned. Offering excellent guarantees on the one hand but less flexibility on the other, it’s important to be clear about the advantages and disadvantages of a defined benefit pension plan – particularly if you’re thinking of transferring. In this article, Angela Maher, Acumen Managing Director, answers all your burning questions about Defined Benefit pensions.
What is a defined benefit pension?
A defined benefit pension allows an employee to build up a percentage of their annual “pensionable income” for every year that they work for their employer, which is then paid out to them as a combination of a guaranteed pension and a lump sum at retirement. Usually, both employer and employee will contribute to the pension.
However, these days fewer and fewer employers are offering Defined Benefit pensions with these very valuable guarantees, although the NHS, teachers, civil servants and Local Authority employees still have them, as well as some large employers. The guarantees are provided by the employer, so these pension arrangements carry a good deal of responsibility and cost. Which is why so may have been closed to new entrants.
Advantages and disadvantages of a Defined Benefit pension plan
If the employer runs into financial trouble and collapses, the Pension Protection Fund is a “lifeboat” fund that protects the pensions so the members don’t lose out. Despite the fact that very large pension benefits aren’t fully protected, most people will find that at least 90% of their pension will be safe even if the employer has failed.
The flipside of the very valuable security that Defined Benefit pensions provide is that they don’t offer the flexibility that Defined Contribution pensions do. With a Defined Benefit pension, you take the pension and the tax-free cash lump sum payment on retirement and then the pension is index linked. It pays out each month throughout your life and then usually pays a pension to your spouse if he or she outlives you.
However, there’s no flexibility to take extra in the early years if your plans are to spend more in the first years of retirement and, if you take another job and feel you don’t need the pension (or the tax bill that will come with it) you can’t suspend it. If you want to leave your pension to your children or other family, Defined Benefit pensions only offer limited pensions to financial dependents and adult children generally don’t qualify for this.
The guarantees are the big benefit though. You’ll know that you have a guaranteed, index-linked income that will last you throughout your life – you can’t outlive your pension.
How to calculate the value of a Defined Benefit pension plan
Your HR or Pensions department will be the first port of call. You need to ask for an up to date statement of benefits which will give you the confirmation that the records are all up to date. It will show the number of years and days you’ve been a member of the pension scheme and it will tell you what you’ve built up so far.
If you no longer work for the same employer you need to be very careful here, as the statement will probably show what you earned up to the date of leaving. The more time that’s passed since then, the more the benefits need to be adjusted. It’s common to look at a statement like this and think that the pension is too small to be worthwhile but once the figures have been brought up to date you may get a very pleasant surprise. So it’s important to make sure what you’re looking at is absolutely accurate.
When can you take a Defined Benefit pension plan?
Every scheme will have a Normal Retirement Age but by law you can start drawing your pension from your 55th birthday onwards. Most pension schemes will allow early retirement; however, you’ll get less in benefits because you’re taking the pension early. You might find that the penalties are too great to retire at 55 but maybe by 59 the penalties are more acceptable. It’s important to get the right information to make a good decision.
Can you transfer a Defined Benefit pension?
If your pension is what’s described as a “Public Sector unfunded pension scheme” you won’t be able to transfer out of the Defined Benefit Scheme into the more flexible, but unguaranteed, Defined Contribution scheme. This is because pension contributions from current employees collected today are effectively used to pay out pensions to retired members tomorrow – it’s a “Pay as you go” system, just like the State Pension scheme.
So there’s no individual fund for each doctor, nurse, teacher or civil servant. Local Authority and private sector schemes are different though. They do have an individual “pot” for each member and it’s these pensions that can be considered for a transfer.
Always seek professional pension transfer advice
There’s no such thing as a “no-brainer” when it comes to considering whether a pension transfer is right for you. It’s crucial to get fully researched, specialist financial advice from a Pension Transfer Specialist firm, such as Acumen. Our three-stage framework starts with a free video that gives you an unbiased explanation of the key points to think about when considering a pension transfer. Our professional advisers can then talk you through your options in detail and in full confidence.
For more information about Defined Benefit pensions or to discuss your pension in greater detail, contact Acumen today on 0151 520 4353 or firstname.lastname@example.org to arrange a meeting with one of our experienced pension advisers.