Defined Contribution v Defined Benefit: What's the Difference?

There are two types of workplace pension – defined contribution and defined benefit - your employer can tell you which one you have. Both are designed to help you save over the long term and provide an income when you retire from working, so you can carry on enjoying your hobbies, holidays and essentials in later life.

Although both types of pension are different, there are some general things that apply to most workplace pensions: auto-enrolment, employer contributions, tax-free saving and investments.

Auto-enrolment

When you start working for a company, the law requires you to be automatically enrolled into a pension scheme if you’re eligible. To be eligible, you must be:

• Classed as a ‘worker’
• Between the age of 22 and state pension age
• Earning at least £10,000 per year
• Working in the UK

You can choose to opt-out if you want, but you might miss out on some great benefits if you do. You can always opt back in later if you change your mind.

If you’re aged between 16 and 21, you’re entitled to join your workplace pension scheme, but you won’t be automatically enrolled. Speak to your employer if you’d like to join.

Employer contributions

The contributions you and your employer make will depend on your employer and the amount you earn. If you’re automatically enrolled, the minimum required by law is 5% from you and 3% from your employer.

With defined contribution schemes, you can usually change the amount you pay. If you do, your employer might increase their contribution too.

With a defined benefit scheme, you and your employer also pay monthly contributions, and the pension you ultimately receive will be based on how long you’ve worked for the company and how much you earned while you were there.

Tax-free saving

With both schemes, the contributions are paid straight into your pension before tax and National Insurance are taken off your earnings, which means you don’t pay tax on them.

Investments

The contributions you and your employer make are invested into assets like company shares, property and bonds. This gives your money the best chance to grow over an extended period of time, but the value of your pension can go up or down depending on market conditions.

With a defined benefit pension, your employer takes on the risk of those market fluctuations. With a defined contribution pension, you take on that risk.

Defined contribution pension

Is my DC pension safe?

Yes - your DC scheme is in safe hands. It’s run by a registered pension provider, not by your employer. So if anything happens to your employer, your pension savings will be safe.

Pension providers are regulated too, either by the Financial Conduct Authority (FCA) or The Pensions Regulator. So if anything happens to the pension provider, you might be able to claim compensation from the Financial Services Compensation Scheme (as long as your provider is authorised by the FCA) or via the Pensions Ombudsman.

What happens if I change jobs?

All the contributions you and your employer pay into your workplace pension will automatically stop when you leave a job, but the savings you’ve built up belong to you. There are a few options available to you at this point:

• Leave your pension where it is and let the pension provider carry on investing it until you’re old enough to start taking it (your employer can tell you who the pension provider is if you don’t know)
• Transfer it to a new pension provider
• See if it can be transferred and merged into the DC scheme at your new job.

Tip: Consider taking financial advice before transferring a pension. Some providers charge for transfers, plus, a different provider might invest your funds in a way that doesn’t suit you or might charge more for managing your pension.

How can I take my DC pension?

The earliest most people can start accessing their DC pension is age 55. When you do eventually start taking it, you’ll have a few options:

• Guaranteed income (annuity) – this is when you use the money from your pension to buy a regular income, either for a fixed period or for life (a bit like receiving a monthly salary). Find out more.
• Flexible income (drawdown) ­­- this is when you take lump sums from your pension pot as and when you want, but you use up your 25% tax-free lump sum first. Once your 25% tax free runs out, you pay tax on the full amount of every other lump sum you take. The rest stays invested, which means it can go up and down in value, so there’s no guarantee you’ll get a set amount. Find out more.
• Flexible lump sums / uncrystallised funds pension lump sum (UFPLS) – if you choose to take your savings in flexible lump sums, 25% of each lump sum will be tax-free and the rest will be subject to income tax. Find out more.

Whichever pension option you choose, 25% of the total value of your pension savings can be taken as a tax-free lump sum.

The normal minimum pension age is due to increase to 57 in 2028.

Defined benefit pension

DB pension schemes aren’t as widespread as they used to be. They pay a guaranteed income for the rest of your life when you retire.

What if something happens to my employer?

The DB schemes TPT looks after are protected by the Pension Protection Fund (PPF). The schemes pay a special levy to ensure members are protected. If something happened to your employer that meant there was no way it could meet the cost of your pension benefits, your DB pension scheme would be able to be transferred to the PPF.

When a transfer takes place, the PPF takes over management of the scheme, including payment of your pension. How much you receive will depend on whether or not your pension is being paid at the time of the transfer.

What if I get a new job?

If you leave your job before retirement age, you’ll get a regular statement showing how much you’ve built up in your DB pension. You could potentially transfer it to your new employer’s pension scheme. However, it’s worth getting financial advice before making any decisions (and this is generally required by law), because you might lose some of your benefits and end up worse off.

If you’re thinking about transferring your pension to another scheme, it’s important to be aware of the risk of pension scams.

How can I take my DB pension?

Once you reach Normal Retirement Age (65), you’ll be able to access your pension in line with the options set out in the rules that apply for your employer’s pension scheme.

You’ll usually be able to take a pension commencement lump sum of up to 25% of the value of your total DB pension benefits tax-free. You’ll also normally receive a guaranteed income paid in regular instalments (TPT usually pays this quarterly) for the rest of your life.

If you access your pension before 65 (except if you are retiring due to ill-health, in which case special provisions apply), you won’t receive full benefits because you won’t have been in the scheme for as long, and pensions that are paid early are expected to be paid for longer. 

Guidance and support

There’s a lot to think about when it comes to your pension, so you might want to speak to an expert before making any decisions. See if you could benefit from financial guidance or financial advice to understand your options and get the most out of your retirement savings.