- Helping members of occupational pension schemes to better understand their benefits.

19th October 2019
:: Scheme Member | Types of Pension Scheme | What is a defined benefit scheme with a money purchase underpin? | Active members of a DB scheme

What is a defined benefit scheme with a money purchase underpin? Active Members
There are many types of pension scheme offered by employers for their employees. This Factsheet looks at a variation of the defined benefit scheme – often called ‘salary-related’ pension schemes - which has for years been the most important part of many employees’ pension benefits.
It is written for people who are active members of a defined-benefit scheme with a money purchase underpin. 
This Factsheet takes a detailed look at a variation of a defined benefit scheme. Even though there is an element of the pension benefit which is money purchase (i.e. an ‘underpin’), because a defined benefit scheme provides a ‘promise’ to the emerging pension, schemes with a ‘money purchase underpin’ are still regulated as defined benefit schemes. For more specific information on money purchase benefits see our Factsheet What is a money purchase scheme?
To understand defined benefit schemes, you ought to know the very basics about employers’ pension schemes. See our Factsheets What is a pension scheme? and Types of employer sponsored pension schemes. There is also a more detailed explanation in our Factsheet, What is a defined benefit scheme? which you should read in conjunction with this one.
What is a defined benefit scheme with a money purchase underpin?
In its simplest format, a defined benefit scheme with a money purchase underpin provides you with two alternative pension options from the same pension scheme.
Whenever you draw your pension benefits, you will get the better of: 
  • a ‘defined benefit’ element of the pension scheme
  • a ‘money purchase’ element of the pension scheme
You will not receive two pension benefits: just the better pension from one of the two alternatives.
So, what is a defined benefit scheme?
Most defined benefit schemes provide benefits based upon 4 key elements: 
  • the length of the pensionable service you are credited with as being an active member of the scheme
  • your pensionable salary
  • the formula or rate of ‘accrual’ which uses service and salary to work out your pension
  • the circumstances under which benefits are taken from the scheme (retirement, early payment, early leaver, ill-health, death etc).
Your pension scheme will use a formula, to calculate your pension benefits using these elements. The formula (and the definitions for each part of it) will be set out in the Scheme Rules.
The two most common forms of defined benefit scheme are: 
  • ‘final salary’ schemes where your pension is based upon your ‘final pensionable salary’ in the years immediately before you take your pension, and
  • ‘career average revalued earnings schemes’ (CARE schemes) where your pension is based upon your ‘averaged pensionable earnings’ throughout the whole of the time you are an active scheme member.
Because both types of scheme use your pensionable salary as one part of the formula in order to calculate your pension, they are both commonly referred to as ‘salary related’ schemes, but there is a significant difference between the two.
Sue Evans is an active member of her pension scheme, and is retiring from work. She will receive a pension from her employer’s defined benefit pension scheme. She has been a member of the scheme for 20 years and her final pensionable salary (which is what her pension is based upon) is £30,000 p.a. She earned a pension equal to 1/60th of her final pensionable salary for each year she was in pensionable service (the ‘accrual rate’).
Pensionable Service,           20 years
Final Pensionable Salary,      £30,000
‘Accrual rate’,                    1/60th
Her pension will be:            20 years    x    £30,000
                                      = £10,000 p.a.
A defined benefit scheme provides benefits that are based upon a set of rules which relate to particular members of a particular scheme, at a specific time. The key feature of defined benefit schemes, is that a specific amount of pension benefit will be paid to the members in specific circumstances.
It is not true that defined benefit schemes provide a guaranteed retirement pension. The pension benefit paid will depend upon many factors, with the most important being the scheme’s ability to pay benefits to members as they fall due. If the employer’s business fails, it is likely that benefits will be reduced for some, if not all members (although Public Sector schemes are different in this respect). For further information on this, please refer to our Module, How secure is my pension?
For more specific information on this type of scheme see our Factsheet What is a defined benefit scheme?
What is an accrual rate?
The ‘accrual rate’ is the rate at which you build up pension benefits whilst a member of the pension scheme.
It is most commonly expressed as a fraction, such as 1/30th, 1/60th, 1/80th, 1/120th etc. The lower the bottom number, the better the pension benefit you will receive for an equivalent amount of pensionable service e.g.
Example 1, using a 1/60th ‘accrual rate’
Pensionable Service,           20 years
Final Pensionable Salary,      £30,000
‘Accrual rate’,                    1/60th
Pension:                           20 years    x    £30,000
                                      = £10,000 p.a.
An accrual rate can sometimes be expressed as a percentage e.g., 1.67% (which is simply another way of saying 1/60th in this example). So, in a final salary scheme for example, you may accrue 1.67% of your final pensionable salary for each year of pensionable service.
What is a money purchase underpin?
As well as the ‘defined benefit’ formula, an agreed amount of the employer’s contribution and (normally) all of your contribution will be invested in an investment fund (or series of funds). That fund or ‘pot’ will grow and accumulate interest or investment returns, until you reach the stage when your benefits are due to be paid.
Depending on how much the ‘pot’ has grown, the scheme (or their advisers) will work out how much pension the money in that ‘pot’ can purchase.
The Trustees look at both components (i.e. the pension available from the defined benefit element and the pension available from your money purchase ‘pot’), and you or your dependants will receive the higher of the two.
Some calculations can be very complex and involve other factors as well as those mentioned above.
To understand money purchase pensions in more detail, see our Factsheet What is a money purchase scheme?
What benefits are provided by a defined benefits scheme with a money purchase underpin? 
The benefit that your pension scheme provides can have been designed in whatever way the sponsoring employer wished.
The only limit to the creativity in what the scheme is attempting to achieve, is how much your employer and you are prepared to pay - and the extent that your employer is prepared to commit to keeping it going.
As time has passed, these schemes have changed with the needs of members, of employers (in attracting new employees) and of government.
A defined benefit scheme with a money purchase underpin can either provide an income for life (commonly referred to as a pension) or an income and a lump sum.
Many schemes include the option which allows you to exchange part of your pension for a tax-free lump sum payment. This is called ‘commutation’ of your pension.
Some pension schemes, notably many of the public sector schemes such as the NHS, Teachers, Local Government and Civil Service schemes, provide the tax-free lump in addition to the pension – i.e. there is no exchanging part of your pension for a lump sum although the pension part of the benefit will normally be lower than if this design was not used.
Other benefits may include a spouse’s, civil partner’s or other dependents’ pension, payable in the event of your death. Most schemes also provide a lump sum death benefit for active members of the scheme.
Did I have to join my pension scheme?
You are not normally obliged to join, but your employer may automatically enrol you in the pension scheme. Alternatively, you may be required to work for your employer for a specified period, before you are eligible to join the pension scheme (e.g. 12 months). For more information see our Quicknote, Did I have to join my pension scheme?
What earnings are used in calculating my pension?
The calculations of pensionable salary (sometimes also called pensionable earnings) can be very complex and can involve factors such as maximum amounts to be taken into account, or exclusions of certain types of earnings (e.g. bonuses, overtime). This is important as your pension will be based upon your pensionable salary.
Your Scheme Rules will define precisely what is used to calculate your defined benefits as well as the amount that will go towards your money purchase ‘pot’.
What counts towards ‘pensionable service’?
The Rules of your pension scheme will define what period of your actual service will be classed as your pensionable service. It is not necessarily the full period of your employment as you may have commenced work before you were eligible to join the pension scheme.
Once again, this is very important as the defined benefit element of your pension will be based upon your pensionable service. For more information see our Quicknote, What counts towards pensionable service?
When can I get my pension benefits?
Benefits will normally be payable to you when you reach your scheme’s normal pension age or Normal Retirement Date. This is important as it is the date at which you would normally have been expected to start to draw your pension benefits without the consent of the employer or the Trustees.
Depending upon the rules of your scheme (not all schemes allow these alternatives), you may also be entitled to receive benefits at other dates such as: 
  • Early retirement
  • Retirement due to ill health
  • Terminal illness
  • Late retirement (where you choose to work beyond normal pension age).
Can I calculate these benefits now?
Defined benefit element
If you are an active member your regular benefit statement should tell you what you may get at normal pension age based upon your current earnings.
These figures however, do not guarantee what benefits you will actually receive at normal pension age as circumstances can change in the future, but they should help you plan for your retirement.
Money purchase underpin element
Your regular benefit statement should also mention the ‘money purchase underpin’ element of your pension benefit, although the actual amount credited to your ‘pot’ may not be specifically referred to. This is because the calculation of your money purchase underpin can be quite complex and would normally be done to coincide with the time you are going to draw your pension benefits.
Some schemes are able to tell members what the ‘pot’ was worth at the date the statement was produced. Under these circumstances the ‘pot’ is usually expressed as a monetary amount (i.e. a ‘fund value’), although the actual amount of pension that could be paid from that ‘pot’ may not be detailed (as this depends upon a number of factors at the time you draw your pension benefits).
Your statement will also tell you a few other items, such as your normal pension age and any spouse’s or civil partner’s pension entitlement. Very few pension schemes provide comprehensive benefit statements.
If you cannot find your benefit statement and want to know how much your benefit would be at alternative dates, you should contact your scheme’s Pension Manager.
What are my benefits ‘worth’?
You know that your defined benefit element of your pension scheme will be calculated based on your pensionable salary, the number of years service in the scheme, and the ‘accrual rate’, but this can only provide an approximate figure of what to expect at retirement.
Until the final calculation is made at the time you are due to take your benefits, any other figures you receive will be just an estimate.
Estimating the ‘money purchase underpin’ element can be much more difficult. Unless your pension scheme can express the amount as an actual ‘pot’ at the date you left pensionable service, any ‘money purchase underpin’ calculation will normally be done to coincide with the time you are going to draw your pension benefits.
The real ‘value’ of your benefits may depend upon a lot of other factors which are personal to you. For example, because of your health you may place a high ‘value’ on any dependants’ benefits which the scheme provides on your death.
Other benefits may be much more intangible, such as your preference for having a financially secure retirement and how you achieve this.
Remember, at retirement a comparison will be made of both of the ‘defined benefit’ and ‘money purchase underpin’ elements of your pension benefits and you will receive your pension benefits based upon the best of the two alternatives.
How secure are my benefits?
In a private sector defined benefit scheme, your benefits are only as secure as the funds which have been set aside to pay for the benefits, and the employer’s willingness and ability to continue to support the scheme. After you retire, your benefits will be more secure, but, as the saying goes, nothing in life is guaranteed (except taxes and death). With the introduction of the Pension Protection Fund you may be entitled to ‘compensation’ if the sponsoring employer goes into receivership and your scheme meets the qualifying criteria set to allow compensation to be paid to scheme members. 
In a public sector defined benefit scheme, such as those for nurses, teachers, local government and civil servants, benefits are generally regarded as ‘safe as houses’. Some of these schemes, such as the Local Government Pension Schemes, are ‘funded’ in the same way as private sector schemes but employer contributions come from local taxation such as Council, Local Business Taxation, and through Central Government settlements which come from the taxpayer. These particular schemes would not qualify for the Pension Protection Fund, as it would be expected that the Treasury would one way or another, bail out any such scheme that suffered serious problems. This is clearly a highly political area.
For more information see our Module, How secure is my pension?
Can my benefits and contributions be changed?
Inevitably, this can happen. Any changes in pension legislation might mean that the scheme has to change. Otherwise, there are legal requirements that certain changes can only be made after consulting some classes of members. Any improvements which don’t involve you in a higher cost would not require your consent. You would however, be told of any change.
A scheme must take care that where it grants extra benefits for one class of member, that it does not diminish the security of others. If this is a significant risk, the Trustees should request specific financial funding or guarantees to cover the extra benefits.
‘Section 67’ of the Pensions Act 1995 is legislation that says the benefits of existing scheme members may not be adversely affected by an amendment in relation to those benefits earned before the date of change.
Benefits can be reduced or contributions increased for the future. If you do not consent to the changes, you may have to leave the scheme.
What rights do I have as a member to ensure the scheme is run properly?
Any member can seek election to become a Trustee of their pension scheme, where there is a Board of Trustees. A Trustee is responsible for ensuring the scheme operates according to all the Scheme Rules.
If you are unhappy about any aspect of the scheme contact the Trustees, and if they do not satisfy you having formally pursued the Internal Dispute Resolution Procedure, you can contact The Pensions Ombudsman or The Pensions Regulator depending on your problem. Also, see our list of Useful Contacts.
Summary & Key Points
When making enquiries about your pension benefit it is very important that you make it clear that you are an active member of the scheme rather than a preserved member or pensioner member. Active, preserved and pensioner are different classes of membership of a pension scheme and any definitions and paragraphs contained within your Scheme Rules or scheme literature relating to any benefit may differ considerably between these categories.
On average, people change jobs every 5 to 6 years. It is possible therefore, that you will have more than one pension benefit. For each pension benefit you need to consider the following items: 
  • Is your pension scheme a defined benefit pension scheme? Does it have a money purchase underpin? If yes, what formula does it use to calculate your pension benefit? How is the money purchase contribution calculated?
  • What is the ‘accrual rate’ used in calculating your pension benefit?
  • How much of your earnings, including any bonuses, overtime, allowances and benefits in kind, goes towards your pension earnings?
  • Does your benefit statement give details of the money purchase underpin?
  • Is there any reduction to the amount of earnings that go into calculating your pension benefits, such as ‘integration’?
  • What pension benefits are provided by your pension scheme? Pension, lump sum, death benefits, ill-health benefits, early payment, pension increases?
  • Keep informed. Your scheme may modify benefits and Rules. Legislation may change. Your circumstances may alter.
  • Rules differ from scheme to scheme and are wide and varied in content. Don’t assume that what applies to one of your pension schemes will necessarily apply to others that you may have.
  • HMRC impose rules which registered pension schemes must conform to.
People seldom have identical pensions and you should avoid drawing comparisons with colleagues whose circumstances may at first appear the same but could emerge as having significant differences.
This Factsheet forms part of our Module Types of Pension Scheme and should be read alongside the other Factsheets and Quicknotes in the series.
This is not an authoritative document. Seek professional advice from an appropriately experienced and qualified adviser.
What is a defined benefit scheme with a money purchase underpin? v1.4 – Active
Last updated 14/01/2007
View our Glossary for definitions of the terms used in our Factsheets

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