Defined benefit vs defined contribution pensions
The short answer: a defined benefit (DB) pension promises you a set income for life, worked out from your pay and years of service. A defined contribution (DC) pension builds a pot from what goes in plus investment growth, and what it pays depends on how that pot performs. DB is usually worth far more, because your employer carries the risk and pays much more in.
The two types compared
| Defined benefit | Defined contribution | |
|---|---|---|
| Who carries the risk | Your employer or the scheme | You |
| What you get | A set income for life, rising with inflation | A pot to use as you choose |
| Depends on | Your pay and years in the scheme | Contributions, investment growth and charges |
| Typical employer contribution | About 20% to 30% of pay in the public sector | 3% to 10% of pay |
| Can you take a tax-free lump sum? | Yes, usually by giving up some pension | Yes, usually 25% of the pot |
| What happens when you die | Pension for a spouse or partner, often half or more | The pot passes to whoever you nominate |
| Common in | NHS, teaching, police, civil service, councils, some older private schemes | Most private sector jobs |
How defined benefit works
Each year in the scheme you earn a slice of pension. In a career average scheme, such as the NHS 2015 scheme, you build up 1/54 of that year's pay; each slice then rises with inflation, plus 1.5% a year in the NHS scheme, while you are still working. When you retire, the slices add up to a yearly income paid for life and increased each year with inflation.
Older final salary schemes worked the same way but used your pay at the end: typically 1/60 or 1/80 of your final salary for each year. Most have closed to new members, but millions of people still have benefits in them.
How defined contribution works
You and your employer pay a percentage of your pay into a pot, with tax relief added. The pot is invested, usually in funds chosen by the scheme unless you pick your own. At retirement you can take up to 25% tax-free and use the rest to buy an annuity (a guaranteed income), draw it down gradually, or take it in lumps. If investments do badly, or you live a long time, the money can run out.
What the difference is worth
Take someone earning £35,000 for 30 years, in today's money:
| Pension | What it gives | Rough yearly income |
|---|---|---|
| DB, building 1/54 of pay a year | Guaranteed income | £19,444 |
| DC, 8% in (auto-enrolment level), 3% real growth | Pot of about £135,972 | About £6,119 |
| DC, 12% in, 3% real growth | Pot of about £203,958 | About £9,178 |
To match the DB income through a DC pot, you would need roughly 20% to 25% of your pay going in every year. That is why public sector pensions are often described as worth a fifth or more of salary on top of pay. See public vs private sector pay.
What you pay in
DB members usually pay more themselves: about 5% to 12.5% of pay in the NHS, teachers', civil service and local government schemes, and more for police and firefighters. DC members commonly pay 5%. Tax relief applies to both. See is the NHS Pension worth it?
Flexibility and death benefits
- DC lets you decide how and when to take your money from 55 (57 from April 2028), and the remaining pot can pass to anyone you nominate.
- DB pays a fixed income from the scheme's pension age. You can usually retire early with a reduced pension, and a spouse or partner usually gets a survivor's pension when you die.
- From 6 April 2027, most unused pension pots and death benefits count towards your estate for inheritance tax. See pensions and inheritance tax.
Should you transfer a DB pension?
Very rarely. Transferring swaps a guaranteed, inflation-linked income for a pot you have to manage. If the transfer value is over £30,000, the law requires you to take advice from a regulated adviser first, and most people are advised against it. Be wary of anyone contacting you out of the blue about a transfer.
Having both
Many people have a mix: a DB pension from an earlier job and a DC pot from the current one, plus the State Pension. Use the government's pension tracing service to find old pensions, and see the small pots rule and how much you need to retire.
Illustrations are simplified and not guaranteed. This is general information, not financial advice.
Sources
Common questions
What is the difference between defined benefit and defined contribution?
A defined benefit pension promises a set income based on your pay and years of service. A defined contribution pension builds a pot from what you and your employer pay in plus investment growth; what you end up with is not guaranteed.
Is a defined benefit pension better?
For most people, yes. The income is guaranteed, rises with inflation and lasts for life, and employers pay far more in. The trade-off is less flexibility.
Should I transfer out of a defined benefit pension?
Almost never. You give up a guaranteed, inflation-linked income. If the transfer value is over £30,000 you must take regulated financial advice first, and most people are advised not to.
What is a career average pension?
A type of defined benefit pension. Each year you build up a slice of that year’s pay, which is then increased each year. Most public sector schemes have worked this way since 2015.
What is a final salary pension?
An older type of defined benefit pension based on your pay when you leave or retire. Most have closed to new members, but many people still have benefits built up in them.
How do I find out what type of pension I have?
Check your annual pension statement or ask the scheme. A statement showing a yearly income figure is usually defined benefit; one showing a pot value is defined contribution.