Defined Benefit Pensions Explained

If you have a Defined Benefit pension, you’re holding one of the most valuable financial assets available in the UK. Here’s how they work, what the jargon means, and what you need to know before making any decisions.

What is a Defined Benefit pension?

A Defined Benefit (DB) pension — sometimes called a “final salary” or “career average” pension — promises you a specific annual income in retirement, based on your salary and years of service. Unlike a Defined Contribution (DC) pension, where your income depends on how your investments perform, a DB pension gives you a guaranteed amount for life.

The employer (and the scheme’s investment fund) bear the investment risk. If markets fall, the employer must make up the shortfall. This is why DB pensions have become increasingly rare in the private sector — they’re expensive to provide. Most private sector DB schemes are now closed to new members, and many are closed to future accrual (meaning existing members can no longer build up new benefits).

DB pensions remain common in the public sector. The NHS Pension Scheme, the Teachers’ Pension Scheme, the Civil Service pension, the Local Government Pension Scheme (LGPS), and the Armed Forces pension are all DB schemes.

Final salary vs career average (CARE)

There are two main types of DB pension, and the difference matters significantly:

Final salary

Your pension is calculated based on your salary at (or near) the point you leave the scheme or retire. The formula is:

Annual pension = (Years of service) × (Accrual rate) × (Final salary)

For example, with a 1/60th accrual rate and 30 years of service on a final salary of £60,000:

30 × (1/60) × £60,000 = £30,000 per year

Final salary schemes are the most generous type of DB pension, particularly for people whose salary increases substantially during their career. Most private sector final salary schemes closed to new members in the 2000s.

Career Average Revalued Earnings (CARE)

Instead of using your final salary, a CARE scheme calculates your pension based on your average salary across your entire membership. Each year, a slice of pension is earned based on that year’s salary and the accrual rate. These slices are then revalued (increased) each year to account for inflation or salary growth.

For example, in a CARE scheme with a 1/57th accrual rate (like the NHS 2015 scheme), earning £45,000 in a given year earns you:

£45,000 × (1/57) = £789.47 of annual pension for that year, revalued each year by CPI + 1.5%.

Most public sector schemes reformed in 2015 moved from final salary to CARE.

Accrual rates: how fast your pension builds

The accrual rate determines how much pension you earn for each year of service. Common accrual rates include:

A higher accrual rate means your pension builds faster. The LGPS at 1/49th is one of the most generous currently available. Schemes with a 1/80th accrual rate often also provide a separate tax-free lump sum (typically 3/80ths of final salary per year of service), which partly compensates for the lower accrual.

Revaluation: protecting your pension from inflation

If you leave a DB scheme before retirement (a “deferred member”), your accrued pension needs to keep pace with inflation. This is done through revaluation — annual increases applied to your deferred pension.

Statutory minimum revaluation for deferred pensions is CPI capped at 5% for benefits accrued between April 2009 and April 2030, and CPI capped at 2.5% for benefits accrued after April 2030 (for schemes that use statutory revaluation). Some schemes offer more generous terms.

In payment, DB pensions typically increase annually. Public sector schemes generally increase pensions in line with CPI. Private sector schemes vary — some increase by CPI (capped at various levels), some by a fixed percentage (e.g., 3% or 5%), and some provide no increases at all for benefits earned after a certain date.

Commutation: taking a tax-free lump sum

Most DB schemes allow you to commute part of your annual pension for a tax-free lump sum when you retire. This means giving up some annual income in exchange for a one-off cash payment.

The exchange rate is called the commutation factor. A typical factor might be between 12:1 and 20:1, meaning for every £1 of annual pension you give up, you receive between £12 and £20 as a lump sum.

Example

James has a DB pension of £25,000 per year with a commutation factor of 15:1. He decides to take the maximum tax-free cash:

• Maximum tax-free lump sum: 25% of the “capital value” of his benefits
• He commutes £5,000 of annual pension: £5,000 × 15 = £75,000 tax-free lump sum
• His remaining annual pension: £20,000 per year for life

Whether commutation is worthwhile depends on the commutation factor, your tax position, your health, and what you plan to do with the lump sum. A factor above 20:1 is generally considered good value; below 12:1 is typically poor value.

Some older schemes (particularly those with 1/80th accrual) automatically provide a tax-free lump sum in addition to the pension, without requiring commutation. Check your scheme rules.

Transfer values (CETV): should you transfer out?

A Cash Equivalent Transfer Value (CETV) is the lump sum a DB scheme would pay if you chose to transfer your benefits to a DC pension. It represents the scheme’s estimate of the cost of providing your promised benefits.

How CETVs are calculated

The CETV is based on the present value of your future pension payments, discounted using assumptions about investment returns, inflation, and life expectancy. When interest rates are low, CETVs tend to be higher (because it costs more to fund the same income). When rates rise, CETVs fall.

CETVs fell significantly in 2022-2023 when interest rates rose sharply, and have stabilised since. A CETV is typically expressed as a multiple of the annual pension. For example, a £20,000/year pension with a CETV of £400,000 represents a 20x multiple.

When transferring might make sense

• Serious health issues: If your life expectancy is significantly reduced, you may get more value from a DC pot that passes fully to beneficiaries on death
• Very high CETV multiples: If the transfer value is 25x or more, the maths can work in your favour (though this is increasingly rare)
• No dependants: DB pensions typically stop or reduce when you and your spouse die. A DC pot can be left to anyone
• Flexibility needs: If you need to access funds in an irregular pattern that a fixed DB income doesn’t suit

When transferring usually doesn’t make sense

• You value certainty: A DB pension pays a guaranteed income for life. A DC pot can run out.
• You have dependants: Spouse pensions (typically 50% of your pension) provide lifelong security
• You’re in good health: The longer you live, the more valuable the DB guarantee becomes
• Low CETV multiple: A multiple below 20x usually means you’re giving up too much guaranteed income
• You’re not comfortable managing investments: DC pots require ongoing investment decisions

Pension sharing on divorce

DB pensions are often the second-largest matrimonial asset after the family home. On divorce, there are three main ways to deal with a DB pension:

1. Pension sharing order

The court orders a percentage of the pension to be transferred to the ex-spouse. The ex-spouse receives a pension credit — either within the same scheme (an “internal transfer”) or transferred to their own pension arrangement. This provides a clean break.

2. Pension offsetting

The pension stays intact, and other assets (often the family home) are redistributed to compensate. For example, one party keeps the £500,000 pension; the other gets additional equity in the house. The risk here is that pensions and property don’t always have equivalent value.

3. Pension attachment order

The scheme is directed to pay a portion of the pension income to the ex-spouse when the member retires. This doesn’t provide a clean break — payments stop if the member dies, and the ex-spouse cannot control when payments start.

Pension sharing orders are the most common approach and are generally considered the fairest. Valuing a DB pension for divorce purposes is complex and usually requires an actuary.

GMP equalisation

Between 1978 and 1997, many employees were “contracted out” of the State Earnings-Related Pension Scheme (SERPS) through their employer’s DB scheme. In return, the DB scheme had to provide a Guaranteed Minimum Pension (GMP) — a minimum level of pension benefits.

However, the GMP rules were different for men and women (different State Pension ages, different accrual rates). A landmark 2018 court case (Lloyds Banking Group) ruled that schemes must equalise benefits so that men and women receive the same overall pension for the same service.

GMP equalisation is an enormously complex administrative exercise. Many schemes are still working through it. If you were a member of a contracted-out scheme between 1978 and 1997, you may receive a small uplift to your pension as a result of equalisation. Your scheme should write to you if this affects you.

DB pensions and the State Pension

If you were contracted out of the additional State Pension (SERPS or S2P) through your DB scheme, your State Pension may be lower than the full amount. You’ll see a “Contracted Out Pension Equivalent” (COPE) amount on your State Pension statement. This isn’t additional money — it’s the amount your DB scheme was expected to provide instead of the additional State Pension.

The full new State Pension is £230.25 per week (£11,973/year) in 2025/26, rising to £241.30 per week (£12,548/year) in 2026/27. If you were contracted out, your starting amount may be less than this — but your DB pension should more than compensate.

Normal retirement age and early/late retirement

Every DB scheme has a Normal Retirement Age (NRA) — the age at which you can take your full pension without any reduction. Common NRAs are 60, 65, or State Pension age.

If you retire before your NRA, your pension is usually reduced to reflect the longer period it will be paid. A typical early retirement reduction is 3-6% per year before NRA. So retiring 5 years early at a 5% per year reduction would reduce your pension by 25%.

If you retire after your NRA, your pension may be increased (a “late retirement factor”) to reflect the shorter payment period. Not all schemes offer late retirement increases.

DB pension death benefits

DB pensions typically provide:

• Spouse/civil partner pension: Usually 50% of your pension (some schemes offer more), paid for the rest of the surviving partner’s life
• Children’s pensions: Some schemes pay pensions to dependent children until they reach a specified age (usually 18 or 23 if in full-time education)
• Lump sum death benefit: If you die in service (while still employed and contributing), a lump sum of 2-4 times your salary is typically paid

From April 2027, DB pensions may be included in your estate for Inheritance Tax purposes, alongside DC pensions. The exact treatment of DB death benefits under the new rules is still being clarified.

Practical tips for DB pension holders

• Get your annual statement: Check your projected pension at NRA, any lump sum entitlement, and death benefits. Contact your scheme administrator if you haven’t received one.
• Understand your scheme’s increases: Know whether your pension increases with CPI, a fixed rate, or not at all. This dramatically affects the long-term value.
• Check your commutation factor: Before taking tax-free cash, compare the commutation factor to the value of the income you’re giving up.
• Be very cautious about transfers: The guaranteed income from a DB pension is extremely difficult to replicate. Take regulated advice if you’re considering it.
• Model your total retirement income: Your DB pension is one piece of the puzzle. Combine it with your State Pension and any DC pots to see your full picture.
• Check for contracted-out deductions: If you were contracted out, your State Pension may be reduced. Factor this into your planning.

Key takeaways

• DB pensions guarantee a specific income for life — they’re one of the most valuable benefits an employer can provide
• Final salary schemes base your pension on your salary at leaving; CARE schemes use your career average
• Accrual rates typically range from 1/80th to 1/49th of salary per year of service
• You can usually commute part of your pension for a tax-free lump sum — check the commutation factor
• Transferring out requires regulated financial advice for pensions worth over £30,000 and is rarely in your best interest
• GMP equalisation may result in small uplifts for members of contracted-out schemes between 1978 and 1997
• A DB pension is typically worth far more than its CETV suggests — treat it as the cornerstone of your retirement plan

To see how your DB pension fits alongside your other income sources, model it in the context of a full retirement plan. Our guide on how much you need to retire can help you understand what your total income needs to be.