Defined benefit pension schemes are where the amount paid to you is set using a formula. This is based on how many years you’ve worked for your employer and the salary you’ve earned rather than the value of your investments. If you work or have worked for a large employer or in the public sector, you may have a defined benefit pension.
How are they paid?
These schemes pay out a secure income for life, which increases each year. They also usually pay a pension to your spouse or registered civil partner and/or your dependants when you die.
There are a number of factors that affect income. These include:
- The number of years you’ve been a member of the scheme – known as ‘pensionable service’
- Your pensionable earnings – this could be your salary at retirement (known as ‘final salary’), or salary averaged over a career (‘career average’) or some other formula
- The proportion of those earnings you receive as a pension for each year of membership – this is called the ‘accrual rate’. Some commonly used rates are 1/60th or 1/80th of your pensionable earnings for each year of pensionable service. These schemes are run by trustees who look after the interests of the scheme’s members. Your employer contributes to the scheme and is responsible for ensuring there is enough money at the time you retire to pay your pension income.
When you take your pension, you can usually choose to take up to 25% of the value of your pension as a tax-free lump sum. With most schemes, your income is reduced if you take this tax-free cash, however the more you take, the lower your income will be. Some schemes, particularly public sector pension schemes, pay a tax-free lump sum automatically and in addition to the pension income.
If you want to get your retirement planning underway, get in touch to arrange a complimentary consultation with one of our advisers.