Defined Benefit vs Defined Contribution: Key Differences

Neither label makes a pension universally better because the two types perform different roles. A defined benefit pension normally provides income calculated under scheme rules and can protect the member from investment and longevity risk. It may also provide increases and dependant benefits. A defined contribution pension provides an invested pot whose value can rise or fall, but it can offer more flexibility over how and when benefits are taken. The importance of certainty, flexibility, death benefits, tax, investment control and access varies between people. Existing guarantees, charges and scheme rules must also be considered. Someone who holds both types may benefit from the different characteristics rather than choosing one over the other. A personal recommendation requires a review of the actual pensions and the individual’s wider circumstances.

Check the statement, member portal or scheme booklet. Wording such as final salary, career average, pensionable service, accrual rate or accrued annual pension usually indicates defined benefit. Wording such as fund value, units, investment funds, money purchase or selected retirement date usually indicates defined contribution. Some schemes have more than one section, such as defined benefit rights plus additional voluntary contributions held in an invested pot. Hybrid and cash-balance schemes can also require closer examination. Ask the provider or administrator to confirm the type in writing and whether any guarantees or safeguarded benefits apply. Do not assume a pension type solely from the employer, the scheme name or the fact that you receive an annual statement.

Yes. Many people build up different pension types as they change employers. You might have defined benefit rights from an earlier public-sector or company scheme and defined contribution pots from later workplace or personal pensions. You can also have separate defined contribution additional voluntary contributions connected with a defined benefit scheme. Each arrangement should be recorded and reviewed on its own terms before being considered together within the retirement plan. A defined benefit income may help cover regular expenditure, while defined contribution savings may offer flexibility, but this is not automatically the suitable strategy for everyone. Check the payment dates, tax position, guarantees, beneficiary provisions and risks across all pensions. There is no requirement to transfer pensions merely to make the list shorter.

A defined benefit pension does not normally operate as an individual investment pot for the member. The central benefit is the income promised under the scheme rules. A scheme may provide a cash equivalent transfer value, but this is an amount offered in exchange for surrendering the defined benefits; it is not the same as a fund balance that you already own and can withdraw freely. Transfer values can change and may be guaranteed only for a limited period. When reviewing the scheme, focus on the accrued income, normal retirement age, increases, spouse or dependant benefits and other guarantees, not only the transfer figure. Transferring to defined contribution usually shifts investment, inflation and longevity risks to the individual and can be irreversible.

Not automatically. A defined contribution pension builds an invested pot, so the value can rise or fall and the amount available depends on contributions, returns and charges. Flexible withdrawals or drawdown do not guarantee that the money will last for life. A member can use some or all of the pot to buy an annuity that provides guaranteed income, subject to the terms available at the time. An older defined contribution policy may also contain a guaranteed annuity rate or another special feature, which should be confirmed before any transfer. Retirement projections on statements are estimates based on assumptions and are not promises. The appropriate method of taking benefits depends on income needs, tax, health, other assets and willingness to accept investment and longevity risk.

Some funded defined benefit schemes permit transfers before benefits start, but scheme rules and legal restrictions apply. Unfunded public-sector schemes generally cannot be transferred to a defined contribution arrangement. A transfer normally means giving up the promised income, future increases and dependant benefits in exchange for a cash equivalent transfer value invested in the receiving pension. If the safeguarded benefits exceed the applicable legal threshold, regulated advice is normally required before the transfer can proceed. The FCA’s position is that most consumers are best advised to retain defined benefit pensions, although individual circumstances must be assessed. A transfer should never be treated as routine consolidation. The receiving pension, investments, costs, tax, objectives and alternatives must be examined alongside the benefits being surrendered.

The answer depends on the scheme rules, the member’s age and whether benefits have started. A defined benefit scheme may pay a continuing pension to an eligible spouse, civil partner or dependant and may provide a lump sum or guarantee period. The amount may be a proportion of the member’s pension and eligibility definitions vary. A defined contribution pension may pay the remaining fund to beneficiaries, subject to provider discretion, scheme rules and the tax treatment applying at the time. Review any expression-of-wish or nomination form and keep it current, but understand whether it is binding or used as guidance. Retirement choices can change death benefits, particularly when an annuity is purchased or a defined benefit pension begins, so beneficiary needs should be considered before benefits are taken.

Chesterton Grant can help you identify the documents to request and arrange for you to speak with a regulated, qualified financial adviser. Pension and investment advice is provided by Steve Wright, a True Potential Wealth Management Partner. The adviser can consider how the pension works, the benefits and guarantees it provides, its place alongside other retirement provision and whether any action is suitable. The assessment may conclude that a defined benefit pension should be retained or that an existing defined contribution pension remains appropriate without transfer. Where investments, contributions, consolidation or retirement options are considered, a personal recommendation requires information about your circumstances, objectives, attitude to risk and capacity for loss. Applicable advice charges will be explained before you decide whether to proceed.