‘Defined contribution’ and ‘defined benefit’ pension schemes explained.

What is a Defined Benefit Pension?

What does a Defined Benefit Pension mean?

It’s resonably straightforward to explain defined benefit (DB) pensions. They are pension plans where the benefit you will receive (plus any inflationary increases over time) is defined on the date of your retirement.

There are two types of defined benefit pensions:

  • final salary pension is a pension where your post-retirement benefit is based on your salary at retirement
  • career average defined benefit pension is a pension where the post-retirement benefit is based on the average of your salary across your career with that employer.

Defined benefit schemes are often referred to as final salary schemes, but the terms aren’t technically interchangeable — final salary schemes are actually a type of defined benefit scheme. However, as final salary schemes are the best known the name has stuck.

How do Defined Benefit Pensions work?

A defined benefit pension works by building up an entitlement to a retirement income throughout your working life rather than an actual pot of retirement savings to live off.

That means a defined benefit pension plan is essentially a promise from your employer to pay a pension for life and not a finite pot of cash, as with a defined contribution pension plan.

At retirement, the defined benefit pension fund promises to pay the employee a guaranteed income for the rest of their life, which will usually be indexed to prevent his income being eroded by inflation.

Calculating Final Salary Pensions

The income you’ll get from a defined benefit pension is based on three factors:
  • Number of years you’ve been working for that employer and contributing to their pension scheme
  • Your pensionable earnings (for final salary schemes, this is your salary at retirement; for career average schemes, this is your mean salary across your career)
  • Your pension scheme’s accrual rate (the proportion of your earnings you’ll receive for each year spent in the scheme, usually represented as a fraction, e.g. 1/80th).

The common calculations for working out how much your defined benefit pension is worth are below:

Defined Benefit Scheme Calculation
Number of years in scheme 33 years
Pensionable Earnings £60,000 final salary
Scheme accrual rate 1/80th
30 years * £50,000 * 1/80th
An annual income of £24,750

Defined Benefit Pension Transfer Value Calculator​

If you’re curious and looking to do some rough sums to see if a pension transfer could be right for you then you can use this Final Salary Pension Transfer Calculator to give you a better idea of what you might be offered as a transfer value.

Across the market there is a wide range of transfer values on offer – normally between 20-25 times your pensionable income, although some schemes provide transfer values more than double other schemes, reflecting the wide range of methods used by pension scheme administrators to calculate transfer values. Your pension scheme administrator may print your CETV amount on your annual statement or you may have to request it.

Our Final Salary Pension Transfer Calculator offers you a realistic high and low range CETV estimate, based on current industry averages, on which to base your calculations.

To read our guide on Final Salary & Defined Benefit DB pension transfers, click the link below:

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