There are several types of workplace pension that exist, offering different forms of income in retirement – one being a defined benefit pension, or DBP. Read on to discover what it is and how it works.
What is a defined benefit pension?
A defined benefit pension gives you a guaranteed pension income in retirement, based on how long you’ve been a member of a scheme and your salary when you retire from or leave an employer. Most schemes still open to new members are found in the public sector, and they’ll pay you a guaranteed income for life that increases with inflation each year.
When you die, a reduced pension is usually paid to your dependants – such as your spouse or civil partner. It can vary between scheme, so it’s worth double-checking the scheme rules that apply to you.
How does a defined benefit pension work?
There are two main types of defined benefit pension:
- Final salary
- Career average
Final salary pensions are probably the most well-known, and they use your salary at the date you left the scheme, or at retirement, to calculate your pension. Most schemes open to new members are now career average schemes – so instead of your final salary, they’ll use the average salary over your career in the pension calculation.
Depending on the scheme rules, any tax-free lump sum will either build up separately to your pension or you might get the choice to exchange some of your pension for a tax-free lump sum at retirement. The size of lump sum you get in exchange for £1 of annual pension is unique to your scheme – it’s known as the commutation rate.
Defined benefits vs defined contributions pensions
You may have also heard the term ‘defined contribution pension’ before. It's important not to get these two confused.
A defined benefit pension pays you a guaranteed pension based on your earnings and length of service. That won’t change depending on what’s happening in investment markets.
In contrast, the value of a defined contribution pot (like a SIPP or Ready-made pension) depends on how much you pay in, plus any contributions from your employer and how your investments perform. Learn more about contributing to your pension.
Defined benefit schemes usually have a retirement age of 65 or higher, sometimes linked to the State Pension age. You might be able to take your pension from 55 (rising to 57 from April 2028), but your starting pension will probably be reduced.
Defined contribution pensions can usually be accessed from age 55 (or 57 from 2028).
Despite their differences, you can save into a defined contribution pension like a SIPP or a Ready-made pension alongside your defined benefit scheme to boost your pension savings. If you’re paying into both, you should keep in mind the allowances on what you can pay in each year and the lump sum allowance for tax-free cash when you come to access your pension(s).
Can I transfer my defined benefit pension?
It’s not usually in your best interests to transfer a defined benefit pension. Whilst an up-front transfer value might look attractive, the amount you’re offered needs to be compared against the value of the benefits you’re potentially giving up.
For example, you’ll lose a guaranteed income for the rest of your life that protects you against rising prices, as well as any spouse or dependent's pension that would be paid on your death.
If you’re still considering a transfer, you’ll need to get full financial advice if your defined benefit pension is worth £30,000 or more.
Important information: Remember that the value of investments can change, and you could lose money as well as make it. We don't offer advice, so it's important you understand the risks. If you're not sure, please speak to a financial adviser. These articles are for information purposes only and are not a personal recommendation or advice. Tax treatment depends on your individual circumstances and rules may change. Pension rules apply.
An AJ Bell SIPP gives you complete flexibility on how much you save for retirement, and allows you to decide when and where your pot is invested.
No matter where you are in life, it’s always a good time to plan for your retirement.
Written by:
Charlene Young
Pensions and Savings Expert
Charlene Young is AJ Bell’s Pensions and Savings Expert. She joined AJ Bell in 2014 from a wealth management firm where she worked with private clients and small businesses as a financial planner.
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