The Ultimate Guide to Pension Retirement Options: Understanding DB Pension Schemes

How DB Pensions Work

In the first post, we looked broadly at state pensions. Now, we’ll move towards the deep end and talk about DB pensions. DB stands for Defined Benefit and these plans are so named because the benefit you receive from a DB pension is known right from the start.

Your eventual pension income is defined by a calculation based on three things: Your earnings, your length of membership in the scheme and the accrual rate. For example, if the accrual rate was 1/60^th, say, then you’d earn 1/60^th of your final salary for every year that you worked there.  If you did 40 years for that employer, you’d have 40/60^th of your final salary when you came to take it.

The main complication is the definition of ‘final salary’ For some schemes it is literally the salary you earned in the last year prior to retirement. For others it’s an average of the last three years, or the best three years in the last ten – it can be very confusing, but you’re going to need to find out how your particular scheme works. Final Salary schemes are closing in many sectors, with the best schemes remaining in the public sector, though even those have seen changes.

Many schemes have shifted now to a CARE basis, which stands for Career Average Revalued Earnings. In these schemes the calculation is simpler. Usually you accrue a percentage of your salary for each year that you work. So let’s say the accrual rate is 2.5% and you earn £25,000 that year. You’ll earn a pension of 2.5% of £25,000 which is £625. So, you’ll get £625 per year of pension from the scheme retirement age in return for that year of working.

As you go throughout your career, you’ll add more pension for every year that you work, and the more you earn, the more pension you’ll get. Also, each pension year you accrue will be increased so it should go some way to keeping pace with inflation – this is the Revaluation part of the title. Again, the scheme will have literature or a website where all this will be explained for your specific scheme.

When you get to retirement, you will have an annual pension that will begin at the scheme Normal Retirement Age. Usually, you have some options at that point. You can usually defer benefits and you can usually take them early. If you retire early, the benefits will be reduced because the scheme will be paying you out for longer.

You can often also ‘commute,’ that is, exchange some of your income for a lump sum. There will be a formula for that in the scheme literature. So you might reduce your pension by £2,000 per year in return for a £25,000 lump sum, say. It’s important you understand how your scheme works both in the accrual phase and also your options in retirement.