Defined Benefit v Defined Contribution

weighing apples and pears

What are defined benefit and defined contribution pension schemes?

Large employers often design a bespoke benefits package for their employees. Staff are sectioned off into benefit tiers. A certain level of pension is awarded, usually linked to service.

Many pension scheme sections develop over time, offering different packages. Most recently, workplace pension rules must be satisfied. This involves a minimum percentage of salary contribution from the employer and employee. This led to employers re-structuring their pension provision to satisfy the law.

Employers offer ‘defined benefit’ or ‘defined contribution’ pension schemes

Both are forms of company pension schemes. When a company designs its benefits packages, they may opt for one or the other, or have a combination.

Over recent years, employers have moved toward defined contribution offerings to reduce their costs and long-term liability.

What is a defined benefit scheme?

A DB scheme offers a pre-structured income for retirement. This means that the company pension is responsible for paying the pension. Instead of holding a pension ‘pot’, you have a form of retirement income contract. You may have heard the terms ‘final salary’ or ‘career average’ pension scheme, both could be described as defined benefit.

Due to the long-term costs of paying pensions for the lifetime of former staff, employers have moved away from defined benefit schemes. Only high value and senior staff are offered new membership to defined benefit schemes. Many schemes have been closed altogether.

While a defined benefit scheme may be described as ‘rigid’, a healthy scheme does offer excellent long-term financial security. Defined benefit schemes can be transferred.

Only by claiming and transferring a CETV (transfer value) to a private plan could flexibility and control be achieved.

What is a defined contribution scheme?

The term ‘defined contribution’ scheme is often used to cover a range of pensions. A Group Personal Pension, for example a Scottish Widows or Standard Life GPP, could be described as defined contribution. Many schemes actually title themselves ‘defined contribution’ and are run by major pension management firms such as Blackrock or Fidelity.

A defined contribution is a pension savings scheme. Usually both the employer and employee pay in an agreed amount each month, and the money is invested. Dependent on factors such as cost, investment performance and level of contributions, the pension member will have a pension ‘pot’ to use for their retirement.

A DC plan often acts as a low cost savings plan for employees while they work for the sponsoring firm, but can change upon leaving service. Some DC plans have limited investment options, and preferential costs for ‘active’ members only.

At retirement, a defined contribution plan often can’t function for income drawdown or flexi-access drawdown.

If you wish to take control of your defined contribution pension, you may consider a switch to a private pension such as a SIPP.

A pension switch must always be properly evaluated under advice. Only switch a pension if it will improve your long term financial planning. Improvements may be in relation to cost, investment portfolio options or at-retirement functionality. Consolidating pensions sounds like a nice idea, but isn’t always for the best.

Reviewing your company pension

If you hold a DB or DC scheme, ensure it is regularly reviewed.

You may be able to improve your pension plan and potential retirement income. Look through our free guides to explore and understand your options. If you’re ready for advice, get in touch with us to be linked to a regulated and trusted adviser where you live.

Read our guides to find out more about pension planning. Understand your retirement planning options before getting in touch to be linked to a financial adviser where you live.

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