Defined benefit pensions in Ireland

A defined benefit (DB) pension is a type of occupational pension that offers long-term income security in retirement and is common for workers in Ireland’s public sector or larger organisations. This guide explores what a defined benefit pension is, how it works, and where it fits into retirement planning.

A defined benefit (DB) pension scheme is a workplace pension that provides a set, regular income during retirement. The payout is calculated using a formula that takes a portion of your salary and multiplies it by how long you’ve worked for your employer. 

In Ireland, defined benefit pensions are commonly found in the public sector or with larger employers. Because payments are pre-determined, they offer a level of predictability not typically offered by other schemes.

With a defined benefit pension, the amount you receive in retirement is typically calculated using a special formula that accounts for your length of service and final pay. DB pensions are funded by the employer, who also takes on most of the financial risk. If the scheme underperforms, for example, they are responsible for making up the shortfall.

With defined contribution (DC) schemes, however, both you and your employer make contributions into a personal pension fund. These contributions are invested, and the returns depend on the performance of the investments. As such, the final retirement benefit can vary and the financial risk usually sits with you as the employee.

Because these are employer-sponsored plans, defined pension schemes are a type of occupational pension, where long-term employment helps build a sustainable pension fund for the future. To help protect the real value of your benefits, some defined benefit plans also offer annual adjustments linked to inflation that aim to ensure the pension keeps pace with rising living costs.

A fixed formula is typically used, based on three main factors: your years of service, the scheme’s accrual rate, and your pensionable salary (your basic pay and certain allowances, but not overtime or bonuses).

One of the most common methods multiplies each year of service by 1/60th or 1/80th of your salary. This represents the accrual rate. In simple terms, the longer you stay in the scheme and the higher your pensionable salary, the larger your future pension is likely to be. 

Another key factor in the calculation is salary. Benefits may be based on either:

• Final salary, which is what you were earning close to retirement or when you left the scheme

• Career average earnings, where pension benefits build up gradually over your working life based on what you earn each year.

In most contributory defined benefit pension schemes, the employer takes on the larger share of the funding, although employees may also make regular contributions depending on the specific plan. All contributions go into a centralised, pooled fund, rather than individual accounts. The employer manages this fund to make sure there will be enough to pay pensions in the future.

While in active employment, members can choose to make additional voluntary contributions (AVCs). These extra payments are entirely optional.

In Ireland, access to benefits from a defined benefit pension scheme usually depends on how long you’ve been a member. Most schemes have a minimum membership period, called a vesting period, before you become entitled to preserved benefits if you leave the scheme.

For public sector pensions, the vesting period is normally two years. Once you’ve completed that time, any pension you’ve earned is typically kept within the scheme and paid out when you reach retirement age.

When you retire, benefits are paid out regularly (often monthly) for the rest of your life, making these schemes especially appealing for those seeking predictability in older age. Benefits are generally not affected by market downturns, since the employer takes on this risk.

Benefits usually start at the scheme’s normal retirement age, which can vary depending on the date of joining. Typical ages in Ireland include:

• Private-sector DB schemes: around 65.

• Public service schemes: often linked to the state pension age – currently 66.

• Single public service pension scheme: members must claim their benefits by age 70 at the latest.

You might also be given the choice to take part of your pension as a lump sum when you retire. In Ireland, a portion of this can be taken tax-free, with the remainder paid as regular pension income. The exact rules depend on the pension scheme and individual circumstances.

If you’ve left the company that sponsored your pension, or if the pension plan is winding down, you may be able to access a lump sum (called the transfer value) of your pension and reinvest it in a new scheme. This usually means giving up your guaranteed income in retirement.

In Ireland, transferring a defined benefit pension typically involves moving the value into a buy-out bond or a PRSA.

• Buy-out bond: A standalone pension held in your name, which preserves what you’ve earned until you retire. 

• PRSA (personal retirement savings account): A more flexible option that gives you room to contribute further and let your pension grow over time. 

When you reach retirement age and meet certain conditions, both options can allow you to move funds into an approved retirement fund (ARF). You can then choose how much to withdraw each year or keep your money invested. You can also leave funds to your estate if you don’t need them all immediately. An ARF means taking on responsibility for investment performance.

Because each scheme is different and individual circumstances can affect your options, seeking independent financial guidance can help you make an informed decision.

If you’re thinking about moving your pension from a defined benefit scheme, the transfer value — also called the cash equivalent transfer value, or CETV — refers to how much your pension might be worth today as a lump sum.

The CETV is calculated by the scheme’s actuary using different factors, including your age, salary, how long you’ve been in the scheme, and assumptions about interest rates and life expectancy.

Some people choose to transfer their DB pension scheme for more flexibility in how the pension can be used, but it doesn’t necessarily guarantee better retirement outcomes. Transferring a DB pension usually means giving up the benefit of income for life.

An enhanced transfer value (ETV) is a transfer amount that is higher than the standard CETV. Some employers or pension schemes offer it as an incentive to transfer out of a defined benefit pension scheme, often for people leaving early.

An ETV can increase the lump sum available, but accepting it usually means giving up the same guaranteed lifetime income you would have had by staying in the scheme.

As with any decision about retirement income, it’s important to consider the long-term consequences, not just the immediate value. Keep in mind that pension rules in Ireland are subject to Revenue limits and regulations.

Accessing a DB pension early could be an option if you’re no longer working for the employer where your benefits were earned. In some cases, this might be allowed from age 50. 

Here are some considerations:

• The pension value may need to be transferred to a retirement fund such as an ARF, which would then allow a 25% tax-free lump sum (subject to the rules of the pension scheme). The rest of the pension usually stays invested until retirement.

• Drawing down early may lead to lower pension payouts, since calculations are based on fewer years of service.

• If you leave your job before retirement, your pension may become a deferred benefit, which stays in the scheme until you reach retirement age.

• If you’re forced to retire early due to a serious, long-term illness, you may be able to access your pension before age 50.

• Any withdrawals must follow Irish Revenue rules, which affect how they’re taxed.

It’s worth being aware that defined benefit pensions, while offering predictability, may carry long-term uncertainties.

Employer risk: The sponsor of the scheme (in other words, your employer) is typically responsible for all costs, which means they take on the full risk if funding levels fall short or if members live longer than projected. This could explain why DB pensions are becoming less common. In 2024, only 26% of occupational pensions from current employment were defined benefit, while defined contribution plans made up 69%*.

Inflation risk: For those receiving benefits, inflation could lead to a gradual drop in the real value of income if the pension isn’t index-linked. 

Market and investment risk: While DB pensions promise guaranteed benefits to members, poor investment performance or market downturns can affect the scheme’s funding. This risk is mainly carried by the employer.

Risk of scheme closure: In some instances, rising costs or funding gaps might lead to the scheme closing, particularly if maintaining the benefits becomes financially unsustainable for the employer.

*https://www.cso.ie/en/releasesandpublications/ep/p-pens/pensioncoverage2024/occupationalpensions/

While defined benefit schemes offer a steady income stream, combining them with diversified financial products such as long-term savings accounts can provide a more flexible source of income in later life.

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If you still have questions about defined benefit pensions, here are a few things worth knowing.