Defined Benefit for Dummies: Right for Me?

By Del Lewis

Defined Benefit Plans are qualified retirement plans which are sponsored by employers. Sometimes known as Salary Related or Final Salary Pensions, the plans offer a number of incentives to those who participate, including tax benefits for both the employer and the employee and greater pension stability. Overseen by the Pensions Regulator, all qualified Defined Benefit Plans must adhere to a set of complex legal requirements, as set out in The Pensions Acts of 2004, 2007 and 2008.

How Do They Work?

A Defined Benefit Plan enables the plan holder to draw a guaranteed benefit upon retirement. A range of factors, including years of service, age and salary, will affect how much they will receive.

Typically, both employees and employers will pay into the scheme and this contribution is topped up by the government. The law sets out minimum payment amounts for each party.

These are as follows:

Employers — 1% of ‘qualifying’ earnings. This figure will rise to 3% by 2018.

Employees — 0.8 % of ‘qualifying’ earnings. This figure will rise to 4% by 2018.

The government — 0.2 % of ‘qualifying’ earnings. This figure will rise to 1% by 2018.

In order to ensure eligibility for full benefits under the scheme, employees may be required to stay in the scheme for a certain qualifying or ‘vesting’ period.

What Are the Benefits?

Under qualified Defined Benefits Schemes, it is possible to receive retirement income of about 70%. Defined Benefits are not dependent upon investment, and as such it is possible to make a prediction as to how much you are likely to receive under the scheme. Tools such as the Aon Hewitt Risk Analyzer can help scheme holders ensure they achieve pension stability.

How Are Retirement Benefits Calculated?

Retirement benefits are calculated using a specific formula. This is usually 1/60 but is sometimes 1/80. The final figure will be affected by salary, accrual rate and the number of years an individual has paid into the scheme. Those leaving the scheme early will receive a lower benefit. Number of years x Accrual Rate x final salary = final benefit

Ways to Receive the Retirement Benefit

There are a number of ways scheme holders can choose to receive their retirement benefit.

As a Lump Sum

Scheme holders can opt to take a lump-sum payment of up to 25% of the overall pension-pot value. This lump sum is tax-free, although tax will be payable on the remaining pension. Scheme holders should bear in mind that taking a 25% lump sum at the beginning will reduce future payments by 25%.

Those whose overall pension value amounts to £30,000 or less can now opt to draw the entire value of the pension as a lump sum, 25% of which will be awarded tax-free.

Single Life Annuity

This involves a fixed monthly payment until death.

Qualified Joint and Survivor Annuity

Holders get a fixed monthly payment until death, when at least 50% of the payment is transferred to a surviving spouse. There may also be a survivor lump-sum option available.

About the Author
Del is a HR Consultant with a vast experience in pensions and investment management. Del writes about topics including benefits administration and pensions risk, contributing regularly to numerous business & finance blogs, and collating his work knowledge on his own blog, The Risk Rut. Also you can keep up with Del on Twitter – @DelLewis87.