In a defined benefit (DB) pension, you build up an amount of pension each year based on:
- part of your salary, and
- the number of years you build up the pension.
It’s fairly easy to estimate how much DB pension you’ll get when you retire. For example:
- your pension builds up at 1/60th of your salary each year
- the salary used to work out the pension is £12,000 a year
- you build up pension for 10 years.
Your DB pension would be: 1/60 x 12,000 x 10 = £2,000 a year.
Different types of DB pension include:
- final salary, where your pension is based on your salary near the date you retire or stop building up the pension, and
- career average, based on your average salary during your working life.
At one time most workplace pensions were DB, but they have increasingly fallen out of favour. They’re high-risk and expensive for employers. Employers are responsible for making sure there’s enough money to pay the promised amount of pensions to the members for the rest of their lives – and people are living longer, so the pensions have to be paid for longer. So the costs keep going up.
As a result, there are very few DB schemes open for building up future benefits. They’re almost all closed and are only promising to pay the benefits built up to the closing date.