What’s the difference between a defined benefit pension and a defined contribution pension?
Pensions on divorce can be one of the most complex assets to untangle. The starting point is to understand the main types of pensions and in particular the distinction between Defined Benefit (DB) and Defined Contribution (DC) pensions.
Lets start with the main terms:
Defined Benefit (DB): Guaranteed income for life based on a formula (e.g., final salary or career average).
Defined Contribution (DC): A pot of money that gets converted to an income in retirement, based on how much you and your employer contribute and the investment performance.
The situation is a bit more complex than this though, so lets go a bit deeper.
Pensions Based on Employment Service and Earnings
These include Defined Benefit (DB), Career Average Schemes (CARE) and Hybrid Pensions. Hybrid Pensions are a mix of Defined Benefit and Defined Contribution depending on the scheme rules.
What it is:
Pensions provided by employers that depend on your length of service and earnings during your working years
How it's earned:
The pension is calculated using a formula based on final salary or average salary and the number of years worked. The longer you work for the employer and the higher your salary, the greater your pension income will be.
Why expert input on defined benefit pensions is needed in divorce:
DB and hybrid pensions require specialist pension on divorce expertise to convert the lifetime income streams into cash-equivalent values for a pension sharing order. It’s not as simple as looking at the value that has been provided by the scheme administrators, as they often underestimate the true value, which can leave one party significantly disadvantaged.
Pensions Based on Amount Saved and Investment Performance
These are Defined Contribution (DC) Pensions and include Personal Pensions, workplace pensions, auto enrolment pension schemes, Stakeholder pensions, and Self-Invested Personal Pensions.
What it is:
Pensions where the amount you get depends on the amount saved and how well those savings grow through investment performance
How it's earned:
You or your employer (or both) contribute to a pension pot that is invested
The value of the pot depends on how much has been saved, the charges of the pension and the investment returns, so it can go up or down
At retirement, you make a choice about how to convert this into an income and the income could be secure, for the rest of your life, or could be drawn from the pot, with you taking the risk that you’ll run out of money during your lifetime
Why expert input on defined contribution pensions is needed on divorce:
Defined Contribution (DC) pots are typically the easiest to value - just request the cash-equivalent transfer value - but that’s only part of the story. Many DC schemes include built-in guarantees (for example, protected benefits or guaranteed annuity rates) that may not show up in the headline value yet add considerable extra worth. An age gap between you and your soon-to-be-ex can also tip the scales: the younger person’s pot has more years to grow before retirement and this needs to be taken into account.
State Pension
What is State Pension:
Government-provided income for people who have reached State Pension age
Based on National Insurance (NI) contributions during working life
Provides a fixed income that’s payable for life once the person reaches the State Pension age (currently between 66 and 67, depending on when you were born)
How you might have one:
You automatically accrue State Pension if you’ve paid National Insurance contributions during your working life or receive NI credits (for periods of illness, unemployment, or childcare, for example)
You need at least 10 qualifying years to receive any State Pension, and 35 years for the full amount
The Bottom Line: Splitting Pensions on Divorce
Whether you’re dividing your State Pension, an employer-linked DB/CARE/Hybrid scheme or a Defined Contribution pot, knowing how to split pension assets on divorce is essential