A defined benefit pension scheme is where the benefit of the pension income are known and which are based on both length of service and salary during employment. These schemes are the alternative to defined contribution schemes where the contributions are known during employment but the final income is based on a varying fund and options chosen at retirement.
Defined benefit scheme are also regarded as ‘gold plated’ schemes for their valuable guaranteed benefit during retirement. These consist of an inflation proofed income, spouse’s benefit and guarantee to pay for life.
Defined benefit schemes were created at a time when life expectancy was a lot lower that it is today. Schemes could therefore afford to pay members until their date of death and comfortably take on new members. Medical advances resulting in longer life expectancy has resulting in schemes having to pay out for longer and becoming unsustainable in recent times. Many defined benefit schemes have been closed to new members, being replaced by defined contribution schemes which doesn’t put any burden on the employer.
The pension reforms of 2014 largely ignored making any changes to those in defined contribution schemes and concentrated on giving more access and flexibility to those with defined contributions and personal pension schemes.
The only way for a defined benefit scheme member to take advantage of the freedoms is to give up their benefits and take a cash equivalent transfer value, and move to a personal pension arrangement.
For member protection, the Financial Conduct Authority has put measures in place to ensure anyone looking to move their guaranteed benefits, can only do so, after seeking professional financial advice.
Defined benefit scheme have fantastic benefits but a very inflexible. They can only be taken based on how the scheme rules stipulate and crucially no benefit can be passed on to anyone other than the spouse or partner (except for dependent children in full-time education up to max age 23). For people with larger defined benefit schemes, this has become the main catalyst in the desire to transfer.
A scheme with an annual income of £15,000 a year, might be worth £400,000 as a transfer value. That’s a large amount of money to be lost back to the scheme if the member were to die early without a spouse or partner.
As the ‘pension freedoms’ now allow funds to be passed on to any beneficiary, those looking to protect their wealth might wish to transfer to a personal pension arrangement and have more flexibility with their fund rather than accept the pre-defined guarantees of an occupation defined benefit scheme.