Defined Benefit vs Defined Contribution

The differences between Defined Benefit Pension Schemes & Defined Contribution Pension Schemes.

Defined Benefit Pensions are also known as Final Salary Pensions. Defined Benefit Pension Schemes are historically used by larger companies and public sector organisations. However, more companies are choosing to enrol their workers onto Defined Contribution Schemes. This is because of the introduction of auto-enrolment into workplace pension schemes.

To make it easier to understand, we have outlined the basic features and benefits of the two schemes in an easy to read comparison chart. 

Features

Contributions

Defined Benefit Scheme

Your employer takes responsibility for paying into the scheme. Moreover, they will ensure there is enough money at the retirement age to pay your pension. In addition, some allow you to contribute.

Defined Contribution Scheme

You are responsible for paying money into a Defined Contribution scheme. However, your employer may also make contributions. Tax relief and investment returns help increase the fund.

Flexibility

Defined Benefit Scheme

Normally, you cannot amend your contribution level. However, you may be able to make additional voluntary contributions in a separate plan.

Defined Contribution Scheme

Usually, you have the control to increase or decrease your pension contribution. In a Group or Personal Pension Plan you can also amend where your funds are invested.

Investment Choice

Defined Benefit Scheme

The trustees for the scheme are the only ones able to make investment choices.

Defined Contribution Scheme

In an Occupational Money Purchase Scheme, usually the trustees make the decisions. In a Personal or Group Pension Plan, you can normally choose the fund you would like to invest in.

Charges

Defined Benefit Scheme

There are no fees or charges associated with this type of scheme.

Defined Contribution Scheme

The charges are variable depending on the individual scheme. However, you can usually expect to pay a policy fee and management charge. In addition, potentially a bid or offer spread on older scheme types.

Security

Defined Benefit Scheme

These are protected by the Pension Protection Fund.

Defined Contribution Scheme

These are usually covered by the Financial Services Compensation Scheme.

If You Leave Your Employment

Defined Benefit Scheme

You become a ‘deferred member’ entitled to the benefits when you retire. These are dependent on your length of service. You may be able to transfer your benefits to a new plan. Please note this is not always possible for those with public service pension schemes.

Defined Contribution Scheme

Your accrued funds will be available to you on your retirement. You do have the option to transfer to a different provider. If you have a Personal Pension Plan you can usually continue limited voluntary contributions. However, these must cease when you are 75 years old.

Benefits

Pension Commencement Lump Sum

Defined Benefit Scheme

This depends on the scheme. Some offer a tax free lump sum on retirement. This is alongside the pension income. There will not be a penalty. Whereas others offer a reduced pension income in return for the lump sum. Therefore, it is best to check your individual scheme.

Defined Contribution Scheme

If your fund is within the £1,073,100 lifetime allowance, you can usually take 25% of the total pension fund. This will be as a tax free lump sum in one go or in stages.

Income

Defined Benefit Scheme

The scheme will pay you an income whilst you are living. It will not reduce but may increase in line with inflation. Your income is based on several factors. Some examples are: age, length of service, final or career average salary, and your scheme’s accrual rate.

Defined Contribution Scheme

It is up to you whether to take your income as a lump sum or in set instalments. You can increase, decrease or stop payments throughout your retirement. Alternatively, you can purchase a pension annuity and take a guaranteed income for life.

Retirement Age

Defined Benefit Scheme

Usually, you can take your pension from 55 years of age. However, your scheme may have a different set retirement age. Also, if you retire before this you may incur a penalty.

Defined Contribution Scheme

Usually, you can take your pension from 55 years of age.

Tax

Defined Benefit Scheme

Your payments will be taxed at your usual rate. You will receive these via your usual PAYE system, at their net amount.

Defined Contribution Scheme

Your payments will be taxed at your usual rate. You will receive these via your usual PAYE system, at their net amount.

Lump Sum

Defined Benefit Scheme

It is important to check your scheme as the rules differ between providers.

If you die before taking your pension, your dependants may still receive a tax free lump sum or a taxable regular pension income.

A deferred member means you have already left the scheme. If you are a deferred member, your dependants may be able to take return the contributions you paid in. In addition or alternatively a reduced spouse’s pension may be available.

Defined Contribution Scheme

If you pass away before taking your pension, or your funds have been placed in a drawdown fund, a lump sum may be able to be accessed by your beneficiary(ies). This will be tax free, up to the lifetime allowance, should you die before age 75. Alternatively, taxed at the beneficiaries regular rate afterwards.

With an annuity, you may be able to take a lump sum. This is instead of any capital protection or pension guarantee period. In addition, this will be tax free should you die before 75 years of age.

Survivor’s Pension

Defined Benefit Scheme

It is important to check your scheme as the rules differ between providers.

Most schemes will allow your pension to be paid to a spouse or civil partner on the event of your death. This will be for the entirety of their life.

Furthermore, some allow this to be paid to your children for a specific period. Any pensions will be paid at the recipients usual tax rate. They cannot be transferred to another nominated beneficiary.

Defined Contribution Scheme

With an annuity, a survivor’s pension must have been selected at your point of purchase.

With a drawdown fund, you can choose beneficiaries to receive any remaining benefits, after your death. For instance, if you die before the age of 75, they can choose to take a lump sum or an income. This will be tax free.

Alternatively, they can choose a taxed lump sum at the recipients usual rate after age 75. This will then pass to the recipient’s beneficiaries. But only if they die with any funds remaining in the original contributor’s pension pot.

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