I am 59, earn £90,000 a year and have a small defined benefit pension that matures in five months. It will pay me £22,000 a year (or £114,000 in cash and £17,000 a year).

I’m still working so don’t need the income now. If I defer, they will add 4% to the value of my pension income for each year. However, I’m considering taking the pension and using that as an alternative to salary. I could then pay more from my salary (via salary sacrifice) into my company pension, which stands at just £130,000.

Is this an option? Which would be the more sensible route? If I defer, although it increases by 4%, am I in effect saving the pension company money?

Mike

Tom Selby, AJ Bell Head of Retirement Policy, says:

For those not familiar with pensions jargon, a defined benefit pension promises to pay you an income from a set age (your ‘Normal Retirement Age’). The value of your defined benefit pension is usually determined by your salary (either ‘career average’ or ‘final’) and the number of years you have been a member of the scheme.

For example, someone who is a member of a career average defined benefit scheme that offers a 1/60th accrual rate will build up an entitlement to 1/60th of their career average salary each year they are a member of the scheme.

If their career average salary was £60,000 and they were a member of the scheme for 20 years, they would be entitled to an income of £20,000 a year from their Normal Retirement Age (which will be set out in the scheme rules).

This income usually comes with inflation protection and a promise to pay your spouse an income (often 50% of the income you have been promised) if you die.

As you say, defined benefit members can also normally access a tax-free lump sum when they reach Normal Pension Age, although this often involves accepting a reduction in promised income in return.

While a pension income of £22,000 a year might not feel substantial, bear in mind it is inflation-protected and will be paid every year until you die. The fact you can receive it from age 60 makes it incredibly valuable.

To illustrate that point, if a healthy 60-year-old wanted to buy an annuity (a guaranteed income for life paid by an insurance company) worth around £22,000 a year and paying a 50% spouse’s pension on death, they might need a pension pot worth well over £500,000*.

Some defined benefit schemes will, as you suggest, allow you to defer taking your defined benefit income and provide you with an uplift for each year you choose to defer. The rate of increase you receive will be determined by the scheme’s actuary and should, in theory, be set at a neutral rate. Whether or not deferring will pay off in pounds and pence terms will depend on the deferral rate you are offered and how long you live for.

SALARY SACRIFICE

Turning to the question of what you should do, I can only offer general guidance rather than advice based on your personal situation. If you want someone to consider your overall financial circumstances and recommend a course of action, speak to a regulated financial adviser.

Salary sacrifice is a method of contributing to a defined contribution workplace pension whereby you accept a reduction in salary and your employer promises to pay an equivalent amount into your pension.

A defined contribution pension is simply a pension where you have your own pot of money that is invested over the long-term.

Where defined benefit provides a guaranteed but inflexible income, a defined contribution pension can be accessed in any way you like from age 55 (rising to 57 in 2028), providing additional flexibility and extra responsibility for managing your pot. You will also usually be entitled to an employer contribution, at least up to the minimum level set by automatic enrolment (and often above this level).

The key benefit of salary sacrifice is that because your wages are lowered, it saves both you and your employer National Insurance contributions. Often (but not always), your employer will share their NI savings with you too. In addition, you’ll benefit from upfront pension tax relief (as it is salary sacrifice, you should get all your tax relief automatically) and tax-free investment growth.

IMPORTANT POINT TO CONSIDER

One thing to bear in mind when considering salary sacrifice is the impact it might have if you are made redundant. As your salary will be reduced, it is possible your redundancy entitlement will be reduced too. Taking less salary could also affect things like maternity and paternity pay, mortgage applications and some state allowances.

A key thing to consider in making your decision is the value you place on flexibility versus certainty. By choosing to defer your defined benefit pension, you would effectively be opting for extra secure pension income in the future.

By contrast, if you take the income from age 60 and use the savings to contribute to a defined contribution pension pot via salary sacrifice, you will have a larger flexible pot that will need to be invested and managed over the course of your retirement.

*Figure based on quote obtained from the MoneyHelper annuity calculator on 9 November 2023.

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Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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