Understanding your Defined Benefit pension will enable you to make informed, confident decisions about your retirement. The information given in this guide should be used in combination with the specific terms of the scheme you belong to as well as independent financial advice.
What it is?
Defined Benefit pensions are schemes which receive contributions from both you as an employee and your employer.
When you retire, the scheme will pay a guaranteed annual income, which rises in line with inflation, for the rest of your life.
It also provides a pension for your spouse and potentially other financial dependants.
The income paid by your Defined Benefit pension will depend on four main factors:
- The number of years you have spent in the scheme
- The accrual rate of your scheme (for example: 1/60 or 1/80)
- Your pensionable earnings
- Any Pension Commencement Lump Sum (PCLS) you choose to withdraw
Knowing that the income you receive during retirement is guaranteed, inflation-proofed for the rest of your life and will continue (possibly at a lower level) to your spouse, partner or financial dependants offers many people comfort and security.
However, ensuring that the funds are available to pay that income is your employer’s responsibility. So, what happens if your employer becomes insolvent and is no longer able to pay your pension?
The Pension Protection Fund (PPF) steps in.
Role of the PPF
If your employer is unable to maintain your pension payments due to becoming insolvent, your Defined Benefit scheme will be transferred to the PPF. They will then continue to pay a percentage of your expected income. However, how much they pay you will depend on your employment status at the time of transfer:
- If you have already retired: Your income will continue at the same rate as before
- If you are already retired, but you retired prior to your scheme’s normal retirement age: Your income will depend on how early you retired. For those working until the normal retirement age, this cap is 90%. However, the earlier you stopped working, the lower your entitlement will be
- If you are still employed when the business fails: You will receive 90% of your expected income if you continue working until the normal retirement age. If you continue working past this age, your pension income will rise to reflect this
You already know that Defined Benefit schemes usually continue to pay an income to the beneficiaries you leave behind. It is understandable that many people are concerned about losing this benefit if their scheme is transferred to the PPF.
The good news is that your dependants and spouse will not be left with nothing when you die. But the exact amount will depend on the terms of your original pension.
Cash Equivalent Transfer Values (CETV)
Defined Benefit schemes don’t have a fund value in a similar way to Money Purchase (Personal Pensions, SIPPs and so on) schemes. Instead your income is calculated using the factors we’ve already mentioned.
Therefore, to understand the value of your Defined benefit scheme you need to request a Cash Equivalent Transfer Value (CETV) from the trustees of your pension.
Your CETV will be calculated by taking into account several factors, including:
- Your length of time in the scheme
- The accrual and annuity rates
- Your pensionable earnings
- The scheme’s current performance
- Inflation estimates for the future
Most schemes will accept one CETV application per year, at no cost. However, you may be able to apply for additional calculations in return for a fee. You can do this independently, or ask your financial adviser to do it on your behalf.