What a defined benefit pension is
In brief: A defined benefit (DB) pension promises you a specific income in retirement based on your salary and years of service. Unlike a defined contribution pension, there is no investment pot to manage — your employer (or the scheme) bears the investment risk. DB pensions are increasingly rare in the private sector but remain common in the public sector.
With a defined contribution (DC) pension, your retirement income depends on how much is saved and how investments perform. A defined benefit pension works differently. The scheme promises a specific annual income calculated from a formula, regardless of how the underlying investments perform.
This makes DB pensions one of the most valuable retirement assets. The guaranteed, inflation-linked income they provide can form a reliable foundation that reduces pressure on other savings.
Final salary vs CARE
There are two main types of DB scheme, and understanding which you have determines how your pension is calculated.
Final salary schemes
A final salary scheme bases your pension on your salary when you leave the scheme (or retire) multiplied by your years of membership and divided by an accrual rate.
Example: A scheme with a 1/60th accrual rate, 25 years of service, and a final salary of £48,000 would produce:
25 / 60 x £48,000 = £20,000 per year
The "final salary" is sometimes defined as your salary in the last year, the average of the last three years, or the best year in the last few years. The scheme rules will specify which definition applies.
CARE schemes (Career Average Revalued Earnings)
A CARE scheme calculates your pension differently. Instead of using your final salary, it takes a slice of each year's salary, applies the accrual rate, and then revalues that slice each year in line with inflation (or another measure) until you retire.
Example: In a CARE scheme with 1/49th accrual, if you earned £40,000 in a particular year, that year's pension slice would be:
£40,000 / 49 = £816.33
That £816.33 is then increased each year until retirement by the scheme's revaluation rate (often CPI). After 30 years of membership, your total pension is the sum of all revalued annual slices.
CARE schemes are now more common than final salary, particularly in the public sector. The NHS, Teachers', Civil Service, and Local Government pension schemes all use CARE.
Commutation — trading income for a lump sum
Most DB schemes allow you to give up some of your annual pension in exchange for a tax-free lump sum. This is called commutation.
The rate at which you can trade income for lump sum is set by the scheme's commutation factor. A typical factor might be 15:1, meaning for every £1 of annual pension you give up, you receive £15 as a tax-free lump sum.
Example: With a £20,000 annual pension and a 15:1 commutation factor, commuting £2,000 of income would give you:
£2,000 x 15 = £30,000 tax-free lump sum
Your annual pension would then be £18,000 instead of £20,000 — for life.
Whether commutation is worthwhile depends on how long you live, what you would do with the lump sum, and your other sources of tax-free cash. There is no universally correct answer — it depends on your circumstances.
You can typically commute up to 25% of the capital value of your pension as a tax-free lump sum, in line with HMRC rules.
Inflation protection
One of the most valuable features of a DB pension is that payments usually increase each year to keep pace with inflation. However, the level of protection varies.
Statutory minimum
By law, pensions built up after April 1997 must increase annually by the lower of CPI and 2.5% (known as Limited Price Indexation, or LPI). Pension built up before April 1997 has no statutory requirement for increases, though many schemes provide them voluntarily.
Scheme-specific increases
Many schemes — particularly public sector ones — offer increases above the statutory minimum. Some link increases to CPI, others to RPI, and some provide a fixed annual percentage (for example, 3% per year regardless of inflation).
Why it matters
The difference between CPI-linked and fixed or no increases is significant over a long retirement. At 2.5% annual inflation, a pension that does not increase loses roughly 40% of its purchasing power over 20 years. Inflation protection means your pension income retains its real value throughout retirement.
Guaranteed Minimum Pension (GMP)
If you were in a DB scheme before April 1997, part of your pension may include a Guaranteed Minimum Pension. The GMP was the minimum pension a scheme had to provide to members who were "contracted out" of the State Earnings-Related Pension Scheme (SERPS).
GMP is a legacy concept, but it still affects many people. It has specific rules about inflation increases: GMP earned between 1988 and 1997 must increase by CPI (capped at 3%), while GMP earned before 1988 receives no scheme increases (the State topped up the difference, though this no longer applies to new State Pension recipients).
If your annual pension statement mentions GMP, it is worth understanding how much of your total pension it represents, as the inflation rules differ from the rest of your DB pension.
Transfer values
Every DB scheme member can request a Cash Equivalent Transfer Value (CETV) — a lump sum that represents the estimated capital value of your future pension income. You can transfer this to a defined contribution scheme (like a SIPP), giving you flexibility but also taking on investment risk.
Why transfers are complex
Transferring a DB pension means giving up a guaranteed, inflation-linked income for life in exchange for a pot of money that must be invested and managed. The risks include:
- Investment risk — the pot may not grow enough to replicate the DB income
- Longevity risk — you might live longer than expected and run out of money
- Inflation risk — without built-in increases, your income may not keep pace with prices
- Scam risk — pension transfer scams are a significant problem in the UK
Regulated advice requirement
For DB pensions with a CETV of £30,000 or more, you are legally required to take advice from an FCA-regulated financial adviser before transferring. This is one of the few areas where the law mandates professional advice, reflecting the seriousness and irreversibility of the decision.
The FCA's starting position is that a DB transfer is unlikely to be in most people's best interest. While there are circumstances where a transfer makes sense (for example, if you are in poor health, have no dependants, or have very specific financial needs), the default assumption is that guaranteed income is valuable and should not be given up lightly.
Tax treatment
DB pension income is taxed as employment income. It uses up your Personal Allowance and is then taxed at the basic, higher, or additional rate depending on your total income for the year.
Your DB scheme will deduct tax at source through PAYE, so the amount you receive in your bank account is after tax. If you have multiple income sources — DB pension, State Pension, drawdown, rental income — the total determines your tax band, not each source individually.
This stacking effect means that a seemingly modest DB pension, combined with the State Pension and other income, can push you into higher rate tax. Understanding how your sources combine is an important part of planning your retirement income.
These projections are for modelling purposes only. They do not constitute financial advice. Tax rules are subject to change. Please consult a qualified financial adviser before making financial decisions.