Public Sector Pensions

Teachers, NHS workers, police, firefighters, the armed forces and some other public sector workers have a special kind of workplace pension: the defined benefit (or final salary) scheme. These are different from most workplace pensions and work according to a specific set of rules. They also contain valuable benefits that you need to know about.

What you need to know about your defined benefit pension

Unlike most pension schemes, a final salary or defined benefit (DB) pension doesn’t depend on a saved pot of money. Instead, it will pay you an income from the start of your retirement until you die, and often a tax-free lump sum too.

How much you receive will depend on your pensionable service (how long you’ve been a member of the scheme), your pensionable earnings (either your salary at retirement, or your average salary over the period of your membership) and the scheme’s accrual rate (the proportion of your salary you receive as pension for each year of service). A typical accrual rate might be 1/80, which means that if you spend 20 years in the scheme, your DB pension would pay you 20/80 (i.e. a quarter) of your final salary. So in this scenario, if you retired on a salary of £40,000 then you’d receive £10,000 a year for the rest of your life.

Most DB schemes will also give you the option of taking a tax-free lump sum at the point of retirement, as well as your guaranteed income for life. In some schemes, taking a lump sum may reduce your annual income, but a lot of public sector pension schemes pay an automatic lump sum in addition to your annual income.

What about pension freedom?

Pension freedom applies only to defined contribution (DC) schemes, giving people access to their pot of money from the age of 55. With DB schemes that pot of money simply doesn’t exist. These schemes were never designed to pay out the entire pension in one go, but over a period of time.

But I’ve heard I can transfer out of a DB pension scheme

It depends on the kind of DB pension you have. Some schemes (such as the Local Government Pension Scheme or private-sector schemes) are known as funded schemes, because they are supported by a central fund. If you really want to, you can transfer out of these DB schemes. Your pension is then moved into a DC scheme, the size of which would be determined by your pension’s transfer value. Be aware that this value is likely to be significantly less than you would have received over your retirement if you had remained in the DB scheme – the advantage would be that you could access it in a variety of different ways, even all at once.

So what about teachers, firefighters, police etc?

Many public sector pensions are ‘unfunded’ schemes – that is, there is no central fund, and they are paid for only by the taxpayer. The pensions of teachers, firefighters, NHS workers, the police and the armed forces all fall into this category. This means it’s not possible to transfer from this kind of pension into a DC scheme – the money simply isn’t there to do this for everyone, so the government ruled it out.

So is that bad news?

The short answer is no. Although some public sector pensions have become less generous than in the past, in most respects they still outstrip the vast majority of DC pensions out there. Admittedly you won’t have the flexibility enjoyed by those who can access their full pension pot from the age of 55 – but that flexibility is a mixed blessing, and can easily lead to the wrong choices being made.

Questions to ask your financial adviser:

  • Is my pension scheme defined benefit (DB) / final salary?
  • Is mine the kind of scheme I can transfer out of?
  • Should I consider transferring, or keep my pension where it is?
  • How much annual income will I receive?
  • How does that compare to what I could buy under pension freedom?
  • What is the best way to use the lump sum I will receive from my pension?