Options for a Defined Benefit & Defined Contribution Scheme from the same employment

The number of Defined Benefit schemes has reduced substantially over the last couple of decades due to the high costs and risks for employers who run these type of pension schemes. This has meant that many Defined Benefit Schemes have been closed to new members or closed completely, leading to many people holding both a Defined Benefit entitlement and also a Defined Contribution Scheme relating to the same employment running alongside each other.

 

What is a Defined Benefit Scheme?  

A Defined Benefit (DB) pension sets out a specific amount that will be paid out to a scheme member once they reach their normal retirement age. The amount will depend on the scheme rules but it will normally be calculated on salary and years of service basis. The employer makes a commitment to pay the retiree an income every year for the rest of their life.

Often there will also be a lump sum paid out at retirement on a standalone basis or else the retiree can opt to take a reduced annual pension in return for a lump sum at their retirement date. This will depend on the scheme rules.

Although there is a commitment, this is not a guarantee. As you can imagine, this is quite a financial burden on the scheme and the employer who funds the scheme. The scheme will be reliant on employer contributions, investment returns and interest rates to fund these current and future payments. If the scheme runs into funding difficulties, it is normally the last entrants into the scheme that will lose out.

 

What is a Defined Contribution Scheme?

A Defined Contribution (DC) scheme is an accumulation of employer and employee pensions contributions that is held in investment account. The value of this pot at the normal retirement age will depend on how much contributions have been made and the investment growth received. At retirement the retiree can take a lump sum from the pension pot and then the balance can be used to either purchase an annuity or invest in a Approved Retirement Fund (ARF) - a post-retirement pension investment account. The retiree will then draw an income from the investment pot.

 

What is the difference between a Defined Benefit Scheme and a Defined Contribution Scheme?

The main difference is a DB scheme makes a commitment to pay out a specific annual income regardless of economic conditions (if possible), whereas a Defined Contribution Scheme relies on the amount that has been paid and investment returns.

With a Defined Benefit Scheme, it is the employer who takes on the investment risk whereas the investment risk with a Defined Contribution Scheme will lay with the employee.

 

When can you access a Defined Benefit Entitlement?

Generally, you will access the benefits of a Defined Benefit scheme at the normal retirement age of the scheme. Historically this would have been age 65 as this was the age when the state pension was previously paid out. The state pension age has changed on a number of occasions over the years. At the time of writing this, it is receivable from age 66, however, the majority of Defined Benefit Schemes still have a normal retirement age of 65.

Some schemes allow members to access benefits earlier than the normal retirement age. The annual income will be reduced by an actuarial calculation in this instance.

There is also the option to take a cash equivalent transfer value. This is the amount the scheme will offer you to transfer out of the Defined Benefit scheme. It is expressed as a lump sum and it can be transferred to another pension structure such as a Defined Contribution scheme or a Personal Retirement Bond. By taking a transfer value, you are relinquishing any right to an income from the Defined Benefit Scheme in the future. This a complex area with risks to be considered so advice should be sought as to whether taking a transfer value is in your best interests as it will depend on a number of factors.

 

When can you access a Defined Contribution Entitlement?

In most instances you can access a defined contribution scheme from age 50, however, this will depend on the scheme rules

 

What happens when you have both a Defined Benefit Scheme and Defined Contribution Scheme relating to the same employment?

There is pension legislation that stipulates that pensions from the same employment must all be accessed at the same time, so in this instance, both the Defined Benefit & Defined Contribution Pensions would need to be accessed at the same time.

Many defined benefit schemes do not allow members to take early retirement which can mean members are restricted in accessing their defined contribution scheme until the normal retirement age of the Defined Benefit scheme, which is normally 65.

Many people want to retire earlier than the normal retirement age. This leads many people to consider taking a transfer value (CETV) from the Defined Benefit scheme where they transfer the value of the pension into another pension structure that does allow early access. Again, this should be discussed with a financial advisor to ensure this is the correct decision taking all of your circumstances into account.

There is another option worth considering for people in this situation. Once you leave employment, you will have a preserved benefit in both the Defined Benefit and Defined Contribution Schemes. A deferred member has the right to transfer a deferred benefit to another scheme.

The member can elect to transfer his Defined Contribution Scheme only; in most cases, a member cannot be forced to transfer both schemes.  The Defined Contribution scheme could be transferred to what is known as a Personal Retirement Bond where there is a right to access benefits from age 50. In this instance, the retiree could access his Defined Contribution Benefit before the normal retirement age while keeping their Defined Benefit entitlement as a separate benefit which will then be payable from the normal retirement age of the scheme. If the Defined Benefit scheme allows early retirement, both schemes must be accessed together. Each scheme will have different rules and advice should be sought in relation to how you can access your pension benefits.

 

Want to find out more?

We do not look at pensions in isolation and as a firm we believe in the Financial planning piece first with the pension piece secondary. We will review your existing pension structures and the options available to you and then make recommendations taking into account your personal circumstances and cash flow needs.

Please contact us if you want to organise a financial planning consultation.