How much do you really know about your pension? We recently surveyed 2,000 defined benefit pension holders in the UK and discovered many were unaware of how their pensions actually work.
To help clear things up, we’re looking at 10 of the most common things people believe – to see if they’re true or false.
But first of all, what exactly is a defined benefit pension?
What is a defined benefit pension scheme?
A defined benefit pension scheme, sometimes known as a final salary scheme, is a fixed sum of money that is paid out from your former employer’s pension scheme when you retire. It will give you a guaranteed income for the rest of your life, however long you live.
We help protect your benefits if you’re in a private defined benefit pension. Defined benefit (DB) pensions are still common in the public sector and there are over 5000 private DB schemes in the UK - though many are now closed to new members. Over 18 million people in the UK have one.
Are your pension beliefs true or false?
From speaking with people about pensions, we’ve identified 10 common beliefs people hold about their DB scheme. Some are true, others are false, but which is which? Test your knowledge by reading the statements below.
1. A defined benefit pension will give me a guaranteed income for life
If you’ve ever been in a DB scheme, you’ll receive a fixed sum of money for the rest of your life. You’ll normally need to reach your scheme’s retirement age to receive your full pension but if you start to receive your payments earlier, you’ll generally receive less.
2. My defined benefit pension will pay me the same as my annual salary
DB pensions are sometimes known as ‘final salary schemes’. This can cause some confusion, since it sounds like you’ll receive the same amount you earned in your final year of work for the rest of your life. Unfortunately, it doesn’t quite work like that.
There are several factors that determine how much you’ll receive each month, including:
- The scheme’s ‘accrual rate’ – the percentage of your salary used to calculate your pension each year
- Rules of the pension - some are calculated by your final salary, others by your average salary
- How long you worked for your employer
- How many pension schemes you had, and what type they were
Some of the factors schemes use to calculate your pension can change over time, so it’s important to stay up-to-date and get regular calculations, so you know where you are when you come to retire.
How accrual rates work
Many DB schemes have an ‘accrual rate’ of 1/80, which means you’ll receive a pension equivalent to 1/80th of your salary, multiplied by the number of years you worked for the employer.
Kelly has worked as a teacher at the same school for the last 20 years and is in a DB pension scheme with a 1/80 accrual rate. In her final year, she is earning £40,000. To calculate the pension from this job:
- She divides £40,000 by 80 = 500
- She multiplies 500 by her 20 years’ service = 10,000
This means Kelly will receive a pension of £10,000 per year from that pension scheme.
3. I’ll lose all my pension if my employer goes bust
One of the many benefits of having a private defined benefit pension is that it’s protected by us. If the employer who provided your DB pension goes out of business, and your scheme doesn’t have enough money to pay you what you were promised, you’ll become a PPF member and we’ll compensate you for your lost pension.
As a PPF member you’ll get 100% of your expected pension if you’ve already reached your scheme’s pension age, or 90% if you’re below that age when the employer fails.
Worried about your pension? Learn more about which schemes we protect.
4. My state pension will be enough to support me in retirement
The state pension can be thought of as a safety net. It’s unlikely to be enough for most people to live on in the UK. For example, in 2021, someone on a full state pension could potentially receive £179.60 per week.
This amount may not be enough to live on between housing, bills, food, and care costs. This is why most people take out some sort of pension – either through their employer or privately.
To see how much state pension you will receive, you can check your forecast on the GOV.UK site.
5. I can only take my defined benefit pension once I stop working
You don’t have to stop working to start to receive your DB pension. Once you reach your scheme’s normal pension age (NPA) you can retire and start to receive your pension whether you’re working or not.
Your NPA is unique to your scheme and is often somewhere between 60 and the state pension age. If you want to start to receive your pension benefits earlier, you can do this in most cases from age 55. This is typically also true for most PPF members.
If you retire early, the amount you receive will often be reduced to reflect the fact that it’s likely to be paid over a longer period of time.
You can also keep working past your retirement age while still claiming your DB pension. Whether you keep working for your former employer, take on occasional jobs or work somewhere new, you’ll still receive your pension.
6. I won’t get taxed on my pension
Many people assume they won’t get taxed on their pension, but this isn’t the case. Your defined benefit pension gets taxed in the same way as any other income. The exact amount you pay depends on which income tax band you fall into. The 2021/22 tax bands are:
- Personal allowance: You don’t pay any tax on income up to £12,750
- Basic rate: You’ll pay 20% on income from £12,571 to £50,270
- Higher rate: You’ll then pay 40% on income between £50,271 - £150,000
- Additional rate: For any earnings over £150,000, you’ll pay 45%
You won’t, however, have to pay National Insurance, which is a kind of tax people pay from the age of 16 until they retire. Depending on your pension provider, you might also receive a tax-free lump sum when you retire.
All of Terry’s pensions combined – including state pension, his DB pension and a personal private pension – amount to £20,000 per year. The first £12,570 is tax free, but he then pays 20% on the remaining £7,430.
7. I have to be working for my employer to receive my defined benefit pension when I retire
If you’ve had a DB pension at any point in your career, you’re entitled to claim it.
There is £19.4 billion sitting in unclaimed pensions in the UK, with the average pot at £13,000. If you think you might have money in a pension from a former employer, you can get in touch with them or use the government’s pension tracing service.
8. To protect my pension, I should transfer out of my scheme before my employer goes bust
If the employer who offered you your defined beneift pension is struggling financially, it’s understandable you’d be concerned about your pension savings. However, your current or former employer can’t access your pension money – it’s usually managed by an independent pension fund with its own trustees.
It’s also important to remember your private DB pension is protected by us. So, if your employer fails, and your pension scheme doesn’t have enough money to pay you what you were promised, your scheme will transfer to us. As a PPF member you’ll still receive an income for life.
Learn more about how we protect your pension.
9. If I get divorced, my partner can lay claim to my pension
If you go through a divorce, your pension will be viewed just like any other asset and will be considered as part of the proceedings. As this is a complex situation, most people will seek legal advice and the outcomes for each party can vary enormously.
Your legal representative will help you agree the best way to divide the assets fairly. If you’re a PPF member, this may result in the Court instructing that your pension is split with your ex-partner. This is known as a Compensation Sharing Order.
For other DB benefits, a Pension Sharing Order may be agreed.
10. If I die, my pension dies with me
Most defined benefit pension schemes provide survivor benefits to a spouse, civil partner or relevant partner when you die but how much they could receive is based on the rules of your scheme.
You can find out if your beneficiary is eligible to receive a pension when you die, from your pension leaving statement or by getting in touch with your scheme directly.
If you’re a PPF member, we’ll pay compensation to your beneficiary if they would have received it under the rules of your former pension scheme. Your children could also receive compensation if they’re under the age of 18 when you die, under the age of 23 and still in qualifying education or have a qualifying disability.
Make sure you speak with your family about your pension so they know what they can expect and how to apply for the money.
Get to know your pension
By taking the time to learn more about your pension, how it works and what you’re entitled to, you can make more informed decisions. It’s always a good idea to get independent financial advice when making any important decisions.
Are you a PPF member? Read our answers to some of the most common retirement questions.