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What type of pension do you have? > Defined Benefit Pension

1. Defined Benefit Pension

Defined Benefit Pensions pay out a secure (guaranteed) income for life that increases every year.

Your employer (or ex employer) manages the scheme and is in charge of making sure there is enough money in the scheme upon your retirement to provide you with your guaranteed benefits.

The amount you receive is based on what your final salary was and how many years you worked (factoring in the accrual or in payment rate).

Neither of these factors has any direct correlation to what the underlying fund is, helping explain why many of these schemes are underfunded.

If the underlying funds the pension is based on don’t have enough money to fund the guaranteed pension, then these pensions can be moved into the Pension Protection Fund, which may have a negative effect on the amount of benefits you receive but still provides a guaranteed income for life.

You may have the option to transfer out of your Defined Benefit Pension. If this is the case, you receive a sum of money that is valued to compensate you for the guaranteed income you are due to receive until death.

If you are considering transferring your Defined Benefit Pension into a Defined Contribution Pension we suggest you look at the PFS Gold Standard website explaining the pro’s and con’s of this. We adopt the PFS Gold Standard principles.

Defined Benefit Pension example (Final Salary Pension)

A typical DB pension would be a 1/80th scheme with a 3/80th contribution, meaning you take the amount of years you have worked for a company and divide it by 80, then multiply it by your final salary, add in the additional 3/80ths, this gives you your income, received annually (but likely to be paid out in monthly installments).

The Commutation Rate will determine how much tax free cash you receive.

The way to calculate the amount of tax free cash you get is by using the following formula (for this example we will use a commutation rate of 15);

  • 20 x pre-commutation amount (how much the scheme pays you per year)
    3 + 20/commutation factor (in this case 15)

So, if you had pension income of £15,000

  • 20 x £15,000 = £300,000
    (3 + 20/15) = 4.33

Therefore, you would get £69,230.77 tax free cash.

Whenever you want up to date pension information, ask your pension administrator for a statement. This will give you a rough idea of what your income might be in retirement. If you have left the scheme, you can still obtain this.

Most schemes work to a retirement age of 65, however, you may be able to attain benefits at 55, but there may be a reduction in benefits for doing so. See the scheme rules for details.

Likewise, you may be able to defer taking income which may increase your income moving forward.

Transferring your defined benefit pension

It is possible to transfer your pension if you are not already taking pension benefits. If your scheme is unfunded you wont be able to transfer.

Transferring to a Defined Benefit Pension with a transfer value of greater than £30,000 requires the help of a pension specialist contact Cambridge Pensions.

Pension Protection Fund

The Pension Protection Fund is in place to cover schemes that do not have enough funding to cover their payment obligations. If you reached the Normal Retirement Date of your scheme pension before the scheme entered the PPF then you will retain 100% of your benefits. If you had not reached your NRD by the time the scheme was moved into the PPF you will be subject to a sliding cap, of which you will receive 90%. This could significantly reduce your pension and place limits on your death benefits.

Pension calculations are complicated, and Defined Benefit pensions in particular. Calculating Defined Benefit input amounts per year is a complex task and it’s often best to get professional advice to achieve maximal performance and utilisation of annual allowance/carry forward.

Contact Cambridge Pensions for assistance with your Defined Benefit Pension.