Sometimes we forget that not everyone has a defined contribution (DC) workplace pension.
In fact, if you’re a doctor or teacher, then you probably have a defined benefit (DB) pension.
But what is a DB pension, how is it different, and how much could I have at retirement age?
Instead of accumulating a pot, a DB pension provides you with a guaranteed income for life.
This is based on how long you’ve been with an employer and the salary you had while there.
DB pensions pay you a secure income for life, which even increases each year with inflation.
They usually even continue to pay a pension to your spouse/partner when you pass away.
In this article, I talk a bit about defined benefit pensions: what they are, their pros, and cons.
I also talk about how you can calculate your potential income with a defined benefit pension.
Finally, I discuss the big question: should you transfer over to a defined contribution pension?
Let’s talk a bit about Defined Benefit (DB) Pensions
DB pensions are pensions that provide you with a guaranteed income for life when you retire.
Your income is calculated by either your final or average salary at the time of your retirement.
These schemes are rare these days. An employer example who uses DB pensions is the NHS.
One advantage is your income is guaranteed regardless of how the underlying assets perform.
Your retirement income is also index linked year on year in order to keep up with inflation.
As well as that, your income will be paid to your partner upon death, but at a reduced rate.
On the flip side some disadvantages to a DB pension is the lack of control in your investments.
You also have reduced flexibility when it comes to how much you can take out as an income.
As well as that, some schemes only grant you access from age 60, 65, or state pension age.
But the key question is: what guaranteed income could you expect when you come to retire?
How much would you have with a Defined Contribution (DC) Pension?
The first thing we need to do is calculate how much income we could have with a DC pension.
This will act as a benchmark, as we’ll be able to calculate our potential income from our pot.
For this calculation, we’ll use the MYB Realistic Pension Calculator and the following variables:
- Starting age is 30, starting sum is £0, starting salary is £42,000, and your contribution is 5%.
- Annual pension growth is 10%, annual salary growth is 3%, and employer contribution is 4%.
After imputing these assumptions into the calculator, we can examine the following results:
- At the time of retirement (in 30 years), this person would have a final salary of around £100k.
- As well as that, after 30 years, they could have a potential pension pot of around £830,000.
Using a 5% withdrawal rate, they could have an annual income of £41.5k or £3,458 a month.
Now we know what this would be for a DC pension, how does this compare to a DB pension?
How much would you have with a Defined Benefit (DB) Pension?
With DB pensions, the calculations are way easier to see how much you’d have in retirement.
Assuming that you have a final salary scheme, the equation for calculating this is as follows:
Final salary x amount of years worked x accrual rate
As in the previous example, let’s say that your final salary with this employer is £100,000
Let’s also say that you’ve been working there for 30 years.
As for the accrual rate, this is normally 1/60th or 1/80th. Let’s say that it is 1/60th.
Therefore, your retirement salary would be = 100,000 x 30 x 1/60 = £50k or £4,167 a month.
As you can see, this is actually more than what you could get with a DC pension and 5% WR.
Even if you use an accrual rate of 1/80, you’d get an income of £37.5k or £3,125 a month.
If that’s the case, you might be thinking: how do I transfer my DB pension into a DC pension?
How much would you get if you were to Transfer?
The first thing to note is that not all DB pensions are transferable to DC pensions.
In fact, if you have an NHS DB pension, this is not transferable unfortunately, amongst others.
Nevertheless, you may have a DB pension that is transferable – so how much would you get?
By transferring your DB pension, your pension provider will give you a sum of money instead.
This is what’s known as a Cash Equivalent Transfer Value (CETV) – so how is it calculated?
There is no clear answer – CETV varies from 20 – 25x your annual income – so let’s try both:
- Using the £50k example above, you’d get between £1 million (20x) and £1.25 million (25x).
- Using the £37.5k example above, you’d get between £750,000 (20x) and £937,500 (25x).
It’s interesting how these pension providers use 20–25 as their multipliers in their figures.
This is equivalent to the 4% rule (25x) and 5% rule (20x) that we use in our FIRE calculations.
My thoughts on DB Pensions
DB pensions are not as bad as I thought they were going to be. In fact, I’d argue they’re better.
The thing that stood out to me about DB pensions is that it’s a guaranteed income for life.
With DC pensions, we’re very much in the hands of the stock market and a withdrawal rate.
It’s nice to know that regardless of how your assets perform that you’ll be paid this amount.
As for the maths I was pleasantly surprised, I expected the income to be much less than this.
However, it is unclear as to what proportion of your ‘final salary’ they actually base this on.
So should you keep your DM pension or transfer it? I’d speak to your provider for more info.
Can you transfer it? What final salary is used in the calcs? What accrual rate do they use?
Regardless of whether you have a DC/DB pension, the early retirement principle is the same:
Use your ISAs to fund your early retirement and then your pensions for your late retirement.
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To find out more about early retirement, check out our articles on retirement and investing.
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