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By Ryan Steward FPFS, Chartered Financial Planner
Sometimes referred to as ‘Final Salary’ pensions, this type of pension has a different way of you receiving your pension benefits, but many of the rules applicable to DC pensions do cross over. You still get your Personal Allowance and Tax-Free Cash, but with a Defined Benefit pension, you decide what income and Tax-Free Cash you want at the start, and you don’t have the flexibility to change that in future years.
For simplicity, let’s use 62-year-old recently retired Daniel again. He needs £15,000 (net) as income, but this time though he has been given a DB quote of £10,000 per annum as income, and £25,000 as Tax Free Cash:
Year One
- £10,000 paid as DB income, he would need to set £5,000 of his initial TFC aside to get him up to his needed £15,000
Year Two
- Same again, £10,000 paid as DB income, he would need to set £5,000 of his initial TFC aside to get him up to his needed £15,000
Year Three
- The State Pension begins, paying Daniel £9,000 of income
- His DB pension pays him £10,000, giving him total taxable income of £19,000
- Of this, £12,570 would be at 0% tax, the remaining (£19,000 – £12,570 =) £6,430 would be subject to income tax at 20%
- £6,430 – 20% income tax = £5,144 after taxes
- £12,570 + £5,144 = £17,714 net income
In this scenario we can see that getting the right income and Tax-Free Cash split right at the start is important. Again, this should be personalised to your individual circumstances, it might be that you have other investments and savings that mean you don’t need Tax Free Cash from your DB pension, thus meaning you can take a higher income from the DB pension.
Your DB income will normally increase each year in line with inflation. If you work with a financial adviser they will look to factor in the anticipated income for the coming year into their advice on other pensions you may hold.
