These Tips are based on frequent, or newer questions that we get.
We can’t give you advice, so can’t tell you what you should do. We can help you get the most from Guiide by understanding how to use our tools better.
Are you lucky enough to have a defined benefit pension scheme income at retirement? Here’s how best to model it.
1. Defined Benefit income
Defined benefit (DB) pensions include final salary schemes and career average schemes. From retirement (what we care about in our modelling) these are essentially the same.
They provide a guaranteed income for life that usually increases in some way or another (linked to inflation, fixed increases, say 3% etc)
They are much rarer these days, but many people may have had one in the past. This will help with their total retirement income wanted. If you’ve been in a public sector job for most of your career, DB schemes make up the majority of your retirement income.
So here is how to model them in Guiide……
2. Retirement date
Every DB scheme has a normal retirement date. This is the date you can take the income from without any reduction. You can also take income from an earlier date if wanted (usually from 55 onwards) but the income will be reduced, as it’s paid for longer.
So first decision is when do you want to start taking income from? If you have no idea, just assume for now it will be from the normal retirement date. This may be on or after the date you start taking any drawdown from your pension pots and savings pots (i.e. the target retirement date in Guiide).
3. Starting Income
If you are still a number of years from normal retirement retirement date, you can usually get a quote from your scheme administrator (or some of the scheme’s online tools if provided) on the starting income from normal retirement date.
There is one issue here. The starting income provided is often in todays money, which means any inflation which is expected between now and payment date has been removed.
If this is the case, lets say the amount shown is £5,000 per year. This isn’t what will actually be paid, it’s what that money is worth today. Whilst this is helpful, its doesn’t really work well in terms of modelling where actual values of pots, income wanted etc are used.
If the amount provided is £5,000 and you are 10 years away from retirement you need to increase this by inflation (which we assume will be 2.5% a year). So £5,000*1.025^10 = £6,400.
This is the figure you enter in Guiide from your normal retirement age. That’s before we consider any cash…..
4. Tax free cash
You can also take tax free cash in most DB schemes. The tax free cash can either be in addition, or more likely, provided if you give up some of the starting pension (known as commutation). You then get a reduced pension plus cash.
If its in addition, this is easy, just put any amount you want to use for retirement income (i.e. not spend as soon as you get it) in Other Cash. This amount then goes straight into savings pots from that date and you can draw this down over time.
If you can only get this by giving up pension, then if you are some time away from retirement, you can usually get a quote of the amount of reduced pension and maximum tax free cash at retirement. Again you need to revalue both as above if its shown in todays money.
Again any tax free cash you won’t spend immediately you can add to Other Cash at the same date as taking your DB pension.
5. More accuracy over time
If you are some time away from retirement, then the above will just be an estimate, but Guiide is not a one off planner.
You can improve the accuracy of the quote in your plan as you get closer to retirement. Eventually you will get very close (within a few months) of when you wish to start taking this DB income and any cash.
At that point you can get a firm quote from a date one or two months away. Then you can use this exact starting pension (which includes any early retirement factors and reduction for cash wanted), plus any cash figure you want to use for income.
Once in payment, whenever you review your plan, you will know how much is in your savings pot that you want to use towards retirement and your current pension.
You can just then keep any savings pots updated and increase the pension amount as actual increases are given each year.
6. Complexities and options
Some DB pensions are quite complex, as various parts have various increases. If you are some time away from taking these, you don’t need to be too accurate and you can just use one DB pension with a overall increase.
At retirement you will have an actual quote which shows how each part increases. At this point and once in payment you can split the different increasing parts up as different DB pensions.
You may have one DB pension which has three different parts. For example, one part increasing at 0%, one at 3% and one inflation linked. To be completely accurate you can put these in as three different DB pensions with the relevant increases for each.
Some schemes have additional options, you can get a higher pension with no increases (called a Pension Increase Exchange Option) or a higher temporary pension to State Pension Age (known as a Bridging Pension Option). These will be quoted to you at retirement if this is the case.
For these more complex options, or if you just more help in general on DB schemes, feel free to contact us at contact@guiide.co.uk where we can try and help you with modelling these
Again, hope this is helpful and more tips coming soon!
