When pensions are discussed, you might hear about two different types: defined benefit pensions and defined contribution pensions. 

Their names may sound similar, but they are very different. Let’s look at the difference between defined benefit and defined contribution pensions.

Let’s start with the main difference:

• Defined benefit pension: The amount of money you receive is usually based on your salary and how long you have been in the pension scheme.
• Defined contribution pension: The amount of money you receive depends on how much you and your employer invest, and how your investments perform.

How a defined benefit pension works

A defined benefit pension (also known as a final salary pension) gives you a guaranteed income for life. The amount of money you get is decided in advance by the rules of your pension scheme, and it increases with inflation. 

You’re more lily to come across defined benefit pensions in the public sector, but some private sector employers also offer them. They are becoming less common today. 

How a defined contribution pension works

With a defined contribution pension, the income you receive depends on how much you and your employer invest in your pension, how well your investments do over time, and how you choose to take the money out.

For example, you can take some or all of it out as a single lump sum, or withdraw it slowly over time. Many people use the 4% rule to give themselves an annual allowance that doesn’t eat into their pension pot too quickly, while allowing their investment to hopefully keep growing.

If you prefer more certainty over how much money you have to spend in your retirement, you may instead choose to buy an annuity. This will give you a guaranteed income for a fixed period of time or for the rest of your life. 

More differences between defined benefit and defined contribution pensions

So what other differences are there between defined benefit pensions and defined contribution pensions? Defined benefit pension schemes are usually managed by a Board of Trustees, so require little involvement from you. In contrast, if you have a defined contribution pension you’ll probably need to make regular decisions about how your money is invested. 

If you have a workplace defined contribution pension you don’t usually have to make decisions as the investments are managed by the trustees or an Independent Governance Committee.

Other differences lie in what happens to your pension when you die. A defined benefits pension can only provide an income for your dependants, while some defined contribution pensions provide different types of benefits to a wider range of potential beneficiaries.

Do the tax implications change with defined benefit and defined contribution pensions?

One thing that doesn’t change, is tax! It doesn’t matter what type of pension you have – your income tax obligations remain the same. 

With most pensions you can withdraw up to 25% tax-free once you reach the age of 55 (rising to 57 from 2028). However, this can be more complicated if you are in a defined benefit scheme. If you do withdraw any money, your provider will probably adjust the amount you receive in future years ahead to reflect the amount you take out.

Can you move your pension from a defined benefit to a defined contribution scheme?

If you are already taking money from your pension, you cannot transfer your money from a defined benefit to a defined contribution scheme. It is also not possible if you have a teachers, civil service, police, armed forces or NHS pension. 

It may be possible if the above does not apply to you. But it’s important to think carefully and get expert financial advice before making a decision. While transferring to a defined benefit pension could bring benefits, such as more control over how your money is invested, it can also be risky, as you lose the security of a guaranteed income.

Remember that defined contribution pensions are tied to financial markets, and if the perform badly, you could end up with less money than you started with. 

It’s also important to note that you can’t reverse a transfer, so once you have left your defined benefit scheme you can’t go back. According to the Financial Conduct Authority (FCA) and the Pensions Regulator (TPR), most people in a defined benefit pension scheme are better off staying.

If your pension is worth over £30,000 and it has safeguarded benefits, such as a guaranteed income or annuity, by law you must get independent advice before transferring.