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This week on the Retire Well with Wealth of Advice podcast, we continue our Pensions Basics mini-series by turning our attention to Defined Benefit (DB) pensions — often referred to as final salary or career average schemes.
In the previous episode, we covered Defined Contribution (DC) pensions, where your retirement income depends on contributions and investment performance. DB pensions work very differently, and for many people they form the most valuable part of their retirement plan.
By the end of this blog, you should have a clear understanding of:
How DB pensions work
How your income is calculated
Your options at retirement
The key things to watch out for when planning around a DB pension
You may also hear DB pensions referred to as final salary or career average schemes. Regardless of the name, they are often described as the “gold standard” of pensions because of the certainty they provide.
A Defined Benefit pension provides a guaranteed income for life, paid by the pension scheme.
The crucial difference compared to DC pensions is where the responsibility sits:
With a DB pension, the scheme and employer are responsible for providing your income
With a DC pension, the responsibility falls on you as the individual
DB pensions were historically common in the private sector but are now largely limited to public sector schemes (such as the NHS, teachers, armed forces, and civil service) and older private sector schemes that are closed to new members.
Your retirement income is not dependent on investment performance. Instead, it is based on your salary and length of service within the scheme.
One of the reasons DB pensions are so valuable is that they provide a guaranteed annual income for life, usually with some form of inflation protection built in. While schemes often apply caps to inflation increases, your income typically rises each year — something that is not guaranteed with Defined Contribution pensions.
A DB pension promises a set annual income, usually paid for life and often increasing each year in line with inflation.
DB schemes typically calculate benefits in one of two ways:
Your pension is based on:
Example:
Over 30 years:
Some schemes use a best-of calculation to work out the salary used in the calculation. For example:
Instead of using a final salary, career average schemes build your pension year by year.
Each year:
Example (simplified):
Some DB schemes also provide an automatic tax-free lump sum on retirement.
For example, the NHS 1995 scheme provides a lump sum equal to three times the annual pension.
Importantly, you do not carry investment risk. The scheme — and ultimately the employer — bears that responsibility.
When approaching retirement, there are two key decisions to consider.
One of the most common areas of confusion with DB pensions is tax-free cash. Many people expect to see a simple 25% tax-free figure, but DB pensions work very differently.
A common misconception is that DB pensions automatically allow 25% tax-free cash in the same way as DC pensions. In reality, the amount of tax-free cash available depends on the scheme’s rules and calculations.
Most DB schemes allow you to commute part of your annual pension in exchange for a lump sum.
Example:
Starting pension: £20,000 per year, no lump sum
Commute pension at a rate of £12 lump sum for every £1 given up
So, if you gave up £5,000 per year scheme pension you could receive £60,000 as a tax-free lump sum.
There is always a maximum amount that can be commuted, and your scheme administrator can confirm your options.
It is important to distinguish between the minimum pension access age (currently 55, rising to 57 in 2028) and your scheme’s Normal Retirement Date.
DB schemes have a Normal Retirement Date (NRD) — the age at which you can take benefits without reduction.
This is commonly:
It is often possible to retire before NRD, but this usually results in a permanent reduction to your pension to reflect the longer payment period.
Most DB schemes pay a survivor’s pension, often around 50% of your pension, to a spouse or dependant after your death.
Understanding these benefits is vital when planning jointly as a couple.
Transferring a DB pension is considered a high-risk decision by the FCA, because you are exchanging a guaranteed income for flexibility and investment risk.
Interest rate changes in recent years have also meant that transfer values can fluctuate significantly. It is not uncommon for transfer values to fall even while the underlying DB pension continues to rise due to inflation protection.
Some schemes allow you to transfer a DB pension into a DC arrangement in exchange for a Cash Equivalent Transfer Value (CETV).
While this can offer flexibility, it also means:
For DB pensions valued over £30,000, taking regulated financial advice is mandatory. Transfers are complex and not suitable for most people.
A listener asked whether drawing income from a DB pension triggers the Money Purchase Annual Allowance (MPAA) — a rule that restricts future contributions to Defined Contribution pensions.
In short: No. Taking income from a DB pension does not trigger the MPAA.
The MPAA only applies when you flexibly access a Defined Contribution pension.
Defined Benefit pensions are often the cornerstone of a retirement plan, providing certainty at a time when many other income sources are less predictable.
Defined Benefit pensions remain one of the most valuable retirement benefits available. They offer:
Understanding how your DB pension works — including retirement age, lump sum options, and spouse’s benefits — allows you to plan the rest of your retirement income with confidence.
In the next episode of the mini-series, we’ll explore Annuities and the State Pension, another key building block in retirement planning.
If you would like help understanding how your DB pension fits into your wider retirement plan, Wealth of Advice can help you make informed, confident decisions.
If you want a better view of what your future could be, we'll have a chat and work out if we make a good fit for you and your financial picture.
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