Defined Benefit Estimator

What is a defined benefit pension, and how does it work?

A defined benefit pension, also known as a final salary or career average scheme, is a workplace pension that provides a guaranteed income in retirement. The income is based on your salary and the number of years you have worked for the employer offering the scheme.

How a defined benefit pension builds up

Each year you are an active member of the scheme, you build up an entitlement to a proportion of your salary, based on the scheme’s accrual rate. In final salary schemes, the pension is based on your pensionable salary near retirement. In career average schemes, the pension is based on your earnings each year, revalued up to retirement.

Your total pension is the sum of these entitlements, calculated at the point you retire or leave the scheme.

How is the income calculated?

The pension income depends on:

• Salary. Either your final pensionable salary or the average of revalued career earnings, depending on the scheme type.

• Accrual rate. This determines how much pension you earn each year. For example, an accrual rate of 1/60 means you receive one-sixtieth of your salary for each year of service.

• Pensionable service. The number of years you have contributed as an active member of the scheme.

• Revaluation and escalation. Most schemes increase benefits before retirement and pension income after retirement in line with inflation or a fixed percentage.

Types of defined benefit pension

• Final salary schemes. Your pension is based on your salary at or near the date you leave the scheme.

• Career average revalued earnings (CARE) schemes. Your pension is based on a percentage of your pensionable earnings each year, with each year’s accrual increased in line with the scheme’s revaluation rules.

What happens when you take your pension?

You can usually begin taking your defined benefit pension at the scheme’s normal retirement age. Some schemes allow early or late retirement, with actuarial reductions or increases depending on when you start receiving the income.

Most schemes give you the option to exchange part of your pension for a tax-free lump sum, within HMRC limits. The income you receive is subject to income tax and is normally paid monthly for life.

Regulation and scheme protection

The Pensions Regulator regulates defined benefit pensions. If your employer becomes insolvent and the scheme cannot meet its obligations, the Pension Protection Fund (PPF) may pay compensation. The level of protection depends on your status at the time the employer failed and the scheme entered the PPF.