The Ultimate Guide to Platforms: Why You Need to Understand DB Pensions

If you have a defined benefits (DB) pension, there are a couple of things you need to do. 

Understand Your DB Benefits

You really need to get your head round any defined benefits pensions you have, so you can translate them into what they really mean for your future.

DB schemes usually work in one of two ways. Either there is an accrual rate, which is usually expressed as a fraction, e.g. 1/60^th. If this is you, then your pension one day will be 1/60^th of your salary for every year that you have been a member of the scheme. So, if you’re in the scheme for 30 years, you’ll get 30/60^th, or one-half of your salary as a pension.

The big question then is how is that salary defined? We used to call these schemes final salary schemes because often that salary was defined as the salary in your last year of the scheme. Some are based on the average salary for your last three years, or the average of the highest five years’ income – each scheme varies.

Many DB schemes are moving towards a career average revalued earnings or CARE basis. These are simpler to understand. In each year, a percentage of your salary will be banked as a future income.

So, let’s say it’s 1.5% and you’re earning £50,000 per year. That means you will bank £750 per year of pension for that year. Of course, if you’re 25 years old and it’s 40-odd years before you can get your pension, that £750 will need to be indexed, or revalued, each year to keep pace with inflation.

Often as schemes switch to a CARE basis, they also put back the retirement age. That’s why you get people working for the NHS who have two parts to their scheme, one 1995 scheme and the other a 2015 scheme, and sometimes other bits to it also.

It’s important to get your head around all this. The simplest way is to look at your annual statement, which will give you a sense of what your pension is worth to this point.

It should usually be expressed in today’s money – the only kind of money we understand, so you can really work out how valuable that pension is. Essentially the statement is saying, if you retired now, this is what you’d get.

The challenge is working out what your future pension might be if you stay in the scheme. This means you’ll need to know the basis of the scheme and its workings. I suggest you take the time to call the pensions department at your company if you’re in a DB scheme and ask them to explain it to you. 

Be Wary of DB Transfers

A hot topic since the pensions freedoms of 2015 has been DB pension transfers. It has always been possible to ask the trustees of a DB scheme to provide you with a cash equivalent transfer value; that is, how much they would pay you to remove your benefits from the scheme and transfer the cash to a personal pension instead.

For many, these numbers have been large, akin to winning the lottery for many folks. Before, they had a vague idea of a future income they’d receive, and now they had a tangible figure in front of them, often multiple six figures or even more, and that was very tempting for many.

The problems with this were manifest. Firstly, for many folks this was the first time they’d ever had access to this kind of money, even if it was via a pension scheme. They weren’t prepared to handle it. They often didn’t fully understand what they were giving up, either. A guaranteed, rising income for life, with a spouse’s pension if you die first, is an incredibly valuable benefit.

Those benefits were guaranteed by the scheme, and if the scheme failed, were largely guaranteed by the Pension Protection Fund. After transfer out, suddenly the responsibility for making sure that their pension fund sustained them for life was in the hands of ordinary folks.

And the advice industry and regulator has singularly let many of these good people down. High-profile mis-selling to members of the British Steel pension scheme is a stain on my profession.

Hard-working steelworkers saw their pension funds disappear into dodgy, high-commission offshore investments with no recourse. The government created a market with the pensions freedoms and its own regulator was too slow to stop the bad practice robbing many thousands of people of their life savings.

And now, in a classic case of shutting the stable door once the horse has bolted, the regulator has really started to crack down, resulting in a tightening PI insurance market for advisers. So now it’s really hard to find an adviser who is willing to take on DB transfer advice, and if you do, you can expect to pay many thousands of pounds in fees.

It is still possible to transfer out your DB scheme, but the regulator’s (and my) view is that for the vast majority of people, DB pension benefits are best left in place. Tread very carefully in this area.