Frozen Defined Benefit Pension Plan: What UK Expats Need to Know

Understanding how a deferred DB pension works can help you plan your retirement income alongside your other assets and consider how living overseas may affect your wider retirement strategy.

This article explains how a frozen defined benefit pension plan works and outlines the main considerations for UK expats when incorporating these benefits into a cross-border retirement plan.

What Is a Frozen Defined Benefit Pension Plan?

A frozen defined benefit (DB) pension is more accurately described as a deferred DB pension. This usually happens when you leave the employer and stop building up further benefits in the scheme. The pension rights you have already earned remain in the scheme.

The primary difference between a deferred and an active DB plan is the accumulation of pension benefits. While you are an active member of a DB scheme, you continue building up pension benefits under the scheme’s benefit formula. Pension benefits grow with each additional year of credited employment, as retirement income in DB schemes is calculated based on your salary and years of service.

What Happens When a DB Pension Is Frozen?

Regardless of the terminology used to describe DB pensions that do not receive contributions, these schemes are not actually frozen. Benefits built up before you leave are generally revalued while they are deferred. The amount of revaluation depends on when the benefits were earned, the type of benefit and the scheme rules.

Unlike defined contribution (DC) pensions, which invest your balance for growth and provide retirement income based on investment performance, DB pensions increase in proportion to inflation or a specific index. The benefits remain in the DB scheme and are normally payable as pension income under the scheme rules unless they are transferred or otherwise dealt with under those rules.

How Is a Deferred DB Pension Calculated?

A DB pension is calculated under the rules of the particular scheme. The formula will usually take account of pensionable service, pensionable pay or earnings, and the scheme’s accrual rate. The two types of defined benefit schemes you may hold are:

1. Final salary schemes: Benefits are usually calculated using your pensionable service, the scheme’s accrual rate and your final pensionable salary, as defined by the scheme rules.
2. Career average revalued earnings (CARE) schemes: Your pension income is calculated according to the average salary received for the duration of your employment until the moment of departure from the service.

While pension income is pre-determined within both plans, the final retirement income you receive from these schemes depends on parameters such as:

1. Retirement age
2. Formula and accrual rate
3. Indexation and inflation

Retirement Age

Each DB scheme has a normal pension age (NPA), which is set by the scheme rules. In some schemes, it may be linked to State Pension age. NPA is generally the age at which you can take your pension without an early-retirement reduction.

Normal Pension Age is separate from the normal minimum pension age (NMPA) under UK pension tax rules. The NMPA is generally 55 and is due to rise to 57 from 6 April 2028, although exceptions and protected pension ages can apply.

Some DB schemes allow you to take your pension before NPA, subject to the scheme rules and the NMPA. Taking benefits early will usually result in an actuarial reduction because the pension is expected to be paid for longer. The reduction depends on the scheme and how early you take your pension.

If the scheme allows you to take your pension after NPA, a late-retirement increase may apply. The rules and calculation vary between schemes.

Should you decide to maintain your deferred DB pension after leaving the UK, consulting a financial adviser at Titan Wealth International can help you understand how the timing of your pension may affect your wider retirement plan. This should take account of your pension arrangements, financial objectives, tax residence and the tax rules that apply where you live.

Formula and Accrual Rate

Both final salary and CARE schemes use an accrual rate to calculate how much pension you build up. The rate is set by the scheme rules and is often expressed as a fraction, such as 1/60 or 1/80. Depending on the DB scheme you participate in, the rate applies as follows:

1. Final salary pensions: The accrual rate is applied to your final pensionable salary, as defined by the scheme, and multiplied by your years of pensionable service.
2. CARE schemes: A proportion of your pensionable earnings is added to your pension for each year of membership. Each year’s pension is then revalued in line with the scheme rules.

Example of Applying the Accrual Rate to a Final Salary

An individual with a final pensionable salary of £30,000 would earn an annual pension of £500 for each year of service if the accrual rate is 1/60. The income is calculated by dividing £30,000 by 60.

If the pension holder was a member of an active DB scheme for ten years, they would receive £5,000 a year in retirement, even if their salary was lower than £30,000 at any point during employment.

Example of Applying the Accrual Rate to a CARE Scheme

If an accrual rate in a CARE scheme is 1/80 and a pension holder leaves the scheme after three years of active membership, assuming their salary increases each year by £10,000:

Once the post-accrual rate amounts are added together, the member would receive a total salary of £1,125 per year, prior to any indexation or inflation adjustments.

Indexation and Inflation

DB pensions may receive increases to provide some protection against inflation. The rules differ depending on whether the pension is deferred or already in payment, as well as when the benefits were built up and the scheme rules.

For pensions in payment, statutory increases generally apply to pension rights built up from 6 April 1997, subject to applicable caps. Broadly:

• 5% cap: Applies to relevant pension rights built up between 6 April 1997 and 5 April 2005.
• 2.5% cap: Applies to relevant pension rights built up on or after 6 April 2005.

These are statutory caps rather than guaranteed rates of increase. The scheme rules may also provide more generous increases.

Deferred DB pensions are subject to separate revaluation rules before retirement. Statutory revaluation generally applies to preserved benefits, although the rate and method depend on when the benefits were built up, the type of benefit and the scheme rules.

How Are Survivor Benefits From DB Pensions Calculated?

If you die before or after taking a DB pension, the scheme may pay benefits to an eligible spouse, civil partner, partner, dependant or child. The benefits available depend on the scheme rules. Other dependants may qualify to receive the death benefit if your provider allows it.

DB schemes provide a guaranteed income based on your salary and years of service, rather than the savings accumulated from investing personal and employer contributions. Instead of your beneficiaries inheriting the remaining balance, your provider decides how DB benefits are paid.

The payout methods vary between schemes, but the available benefits may include:

• Lump sum payouts: Beneficiaries may receive a lump sum if you die before taking your deferred pension. The amount and how it is calculated depend on the scheme rules.
• An income stream payment: An eligible spouse, civil partner, dependant or other qualifying beneficiary may receive a portion of your pension as regular income. The amount payable and eligibility requirements depend on the scheme rules.

Cross-Border Considerations for Expats

Living overseas does not generally alter the pension benefits you have already accrued under a UK defined benefit scheme, although it can affect how those benefits are taxed and how they fit into your wider retirement plan.

One consideration is where you expect to live when you begin receiving the pension. Your country of tax residence may affect how UK pension income is taxed.

Where a double taxation agreement applies, its specific pension provisions can affect the taxing rights of the UK and your country of residence. The position varies between countries and according to individual circumstances, so the tax treatment should be established before making decisions about when or how to take pension benefits.

Currency is also relevant. A UK DB pension will usually pay benefits in sterling. If most of your retirement spending will be in another currency, exchange-rate movements can affect the amount of local-currency income your pension provides. This may need to be considered alongside other pensions, investments, cash and property income held in different currencies.

Your deferred DB pension should therefore be considered as part of your overall retirement arrangements rather than in isolation. For example, you may have a UK DB pension due to start at its normal pension age while also holding a defined contribution pension, overseas investments or property. Understanding when each source of income becomes available, and in which currency, can help you assess how they may work together throughout retirement.

These considerations become especially important before transferring a DB pension. A transfer can permanently change the nature of your benefits and may involve giving up valuable guarantees in exchange for greater flexibility and investment choice. The tax and regulatory implications can also depend on both UK rules and the rules in your country of residence.

What Can You Do With a Frozen Defined Benefit Pension Plan as an Expat?

If you hold a deferred DB pension, you may have several options depending on the scheme rules and your circumstances. If you are considering whether to cash in a frozen DB scheme, the two main options covered here are:

1. Leaving the pension within the DB scheme: Retaining a deferred DB pension means you can receive pension income in retirement under the scheme rules. Your deferred benefits will generally be revalued before retirement, although the rate depends on when the benefits were built up and the scheme rules.
2. Transferring the pension to a defined contribution plan: Many deferred DB pensions can be transferred to a defined contribution plan, although transfer rights and restrictions depend on the scheme and your circumstances. This option may allow you to consolidate pension benefits into a single scheme and invest across a range of assets. However, you would give up the safeguarded benefits provided by the DB scheme and take on investment risk.

Some UK expats consider transferring a deferred DB pension to an International self-invested personal pension (SIPP). A SIPP is a UK pension arrangement that can offer greater investment choice and, depending on the provider, may be available to people living overseas.

Holding pension benefits in a SIPP may offer the following advantages to expats:

• Streamlining pension management from overseas.
• Providing access to a wider range of investments and currencies.
• Providing access to international markets and investment opportunities.

The term “international SIPP” is used to describe some SIPPs aimed at clients living overseas. It is not a separate legal pension structure under UK pension legislation.

Key Considerations When Transferring a DB Pension

Before considering a transfer, check whether you have a statutory or scheme-rule right to transfer the benefits. Members of unfunded public-service DB schemes, including the NHS and Teachers’ schemes, are generally unable to transfer those DB benefits to an arrangement that provides flexible defined contribution benefits.

Once you confirm that a transfer is permitted, you must obtain a cash equivalent transfer value (CETV) from your pension provider. This is the amount your provider offers you for relinquishing guaranteed income and transferring out of the DB scheme. The CETV is calculated on actuarial principles using the scheme’s transfer-value basis and assumptions about factors such as inflation, mortality and future investment returns or discount rates.

If you want to transfer safeguarded DB benefits valued at £30,000 or more to a defined contribution arrangement, you will generally need to take appropriate independent advice before the transfer can proceed.

Titan Wealth International helps you determine whether you should retain a DB pension or consider a transfer to a SIPP, based on your personal circumstances and residency status. If a transfer suits your objectives and circumstances, our DB pension transfer specialists can help you assess the CETV provided by your scheme and, where appropriate, consolidate your pension benefits within a SIPP.

Potential Risks of Transferring a Frozen Defined Benefit Pension Plan

Despite the benefits of transferring a deferred DB pension to a SIPP, opting for a transfer requires careful consideration, as exiting a DB scheme carries the following risks:

• Loss of guaranteed income: After you move a DB pension to a DC scheme, your retirement income is no longer guaranteed, as your savings are linked to investment performance.
• Impact of market volatility: While investing your pension may result in substantial returns, it also exposes your balance to market volatility and potential losses amid market downturns.
• Loss of built-in inflation protection: After a transfer, you give up any inflation-linked increases provided by the DB scheme. A SIPP does not automatically provide equivalent increases, although its investments may rise or fall over time.

Consulting a financial adviser prior to making a final decision helps you gain a full understanding of the advantages and risks that transferring a frozen DB pension carries, ensuring you select an option that best aligns with your goals.