Defined Benefit And Define Contribution Pension Schemes Accounting Essay

Pension is fund that is built during the working life of the employee and so used to procure the income after retirement. These financess can be operated by employer ( occupational pension ) who invests over clip or instead employee can put in a fund of their pick ( private pension strategy ) . Both of these strategies generate income after retirement.

The pension financess are operated in many states. Harmonizing to international fiscal service the UK pension fund is $ 1,464 billion, Germany had $ 268 billion and France had $ 164 billion.

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Pension strategies are of two major types:

Defined benefit strategy

Defined part strategy


Define benefit strategy is besides known as concluding wage strategy which stipulate a peculiar degree of income after retirement usually based on concluding wage and length of service. Although there is a mandatory part by the employee, most of the cost of the benefit and hazard of the investing is borne by the employer.

For illustration, in most of the populace sector pension strategies, UK employers pay 60 % of the cost of supplying the benefits and members pay 40 % .

Assorted factors which consequence the part includes:

Value of the strategy assets and investing output.

A The composing of scheme rank.

A Rate of salary growing of the strategy members.

A Longer life span after retirement.

A Changing regulative demands.

Contributory Defined Benefit Scheme:

In this instance the employees make parts to the pension strategy. Final Salary Schemes and Career Average Salary Schemes are the contributory Defined Benefit Schemes.

Final Salary Scheme: In this instance the pension sum is calculated on the footing of the concluding wage of an employee in that company. From the employer ‘s point of position these are expensive as compared to other pension strategies. The parts for are made by the employee for the pension strategy.

Career Average Salary Scheme: It calculates the pension sum depending upon the mean net incomes over the entire figure of old ages an employee works in a company. The benefits would be a per centum of the mean salary earned by an employee during his calling in that peculiar company. As compared to concluding salary strategy they are less dearly-won for the employers. In this instance besides employee contributes in the pension strategy.

Non- Contributory Defined Benefit Scheme: In this instance the emploer alternatively of employee is responsible for the parts in the pension strategy. Cash Salary Scheme is the non contributory Scheme.

Cash Salary Scheme: This is a non contributory defined benefit strategy. In this instance employer contributes a peculiar sum of money each twelvemonth on behalf of the employee. They are a combination of defined benefit strategy and defined part strategy. For this ground they are besides called as Hybrid Schemes.

Decline in Defined Benefit Schemes:

In define benefit strategy employer bears most of the hazard every bit good if the pension fund become deficient either due to hapless investing public presentation or big salary additions, employer must refill the pension fund out of concern grosss. Operating such strategy on mean net incomes instead than concluding wage can assist to protect against higher rate of salary growing.

Munnell and Soto found that many houses have “ frozen ” define benefit programs since 2003. There are Following are the figure of factors which have been used by employers to explicate the diminution of defined benefit strategies which are described below:

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Defined part strategies are besides known as money purchase strategy in which the employee and/or employer make parts into a pension fund harmonizing to prescribed regulations. At retirement the pension fund is used to purchase rente which is an income guaranteed for life of the receiver. Most of the personal pensions are of his type. Under defined part strategies following factors determine the pension income available at retirement.

The parts invested in the strategy ;

Merchandise supplier charges ;

The public presentation of the pension fund ;

The rente rate at retirement day of the month

The chief factors that determine the benefits at retirement are the parts invested by the employee, the return on investing earned, Annuity rate, the type of rente selected and the charges of the strategy. Due to the features and benefits of this strategy, this is the most popular type of pension strategies used in UK. These parts cover a broad assortment of private and occupational strategies. In this instance the hazard of hapless returns on investing or high cost prevarications with the employee alternatively of employer. The employees can non calculate their pension as the return on investing fund is unsure. The factors impacting the return like rente rate, charges on investings and public presentation of investings are beyond the control of the employee. An employee can besides be certain of the sum of investing made by him. In the initial phases of investing the parts are invested in the investings where hazard is high and as an employee ranges near his retirement his parts are invested in relatively less riskier investings. This provides a good combination of growing and security. Employees in this instance can hold revenue enhancement alleviation on their parts.

The pension fund in this instance hence includes:

Pension Fund = Employee ‘s Contributions + Employer ‘s Contributions + Investment Returns + Tax benefits

The parts are invested in the portions and other investings with the purpose of gaining more return on these investings which can assist in the growing of the pension fund before the retirement of the employees. Employees can take the investings in which they want to put. At the clip of retirement employees can take a revenue enhancement free ball amount sum from their pension and the staying sum can be used to procure an income.

If an employee alterations his occupation he can halt doing payments to his fund and can go forth it as it is with his old employer. This is besides known as Deferred or Preserved Pension. Otherwise with some extra cost and hazard he can acquire it transferred to his new employer or a stakeholder.

Defined parts strategy allows employees to do regular parts. Employer can besides choose for doing parts in the pension fund.


The defined benefit and defined part strategies can be best differentiated by finding where the hazards prevarication.

In a defined benefit strategy, the employer bears the huge bulk of costs and if investing returns hapless output or costs addition, the pension fund can go deficient and the employer must refill the fund out of the concern grosss.

Whereas in a defined part scheme the parts are paid at a fixed degree and therefore it is the receiver who bears these hazards. If they are non able to increase parts when fund public presentation is hapless or cost additions, so their retirement income will be lower.

In UK there is an upper bound from a define benefit strategy where as there is no upper bound to the degree of income generated from this strategy.


Defined Benefit Scheme

Defined Contribuion Scheme



Hazard lies with the employer

Hazard lies with the employee


Change in Value of Investment

Pension fund is fixed and pre determined.

Pension financess have the growing potency. They are flexible and can supply more return.


Affect of Market conditions

Market conditions do non impact the pension fund

Market conditions affect the return on investings made by the employees.


Economic Conditionss.

Economic conditions like rising prices, affects the employees. As they receive fixed sum and the value of money lessenings.

They have less affect of the economic conditions on the investings.


Cost to employer

These have high cost associated with them for the employer.

These programs have relatively low cost.



Duty to do payments lie with the employer most of the times.

Employee is responsible to do payments



These pension strategies have a downward tendency these yearss due to the cost associated with them for the employer.

They have an upward tendency due to the less cost to the employers.



These are relatively more certain. The same sum invested by two different individuals provides the same return.

These are unsure in nature. The employee knows the sum he or his employer invested but he is unsure about the return on this investing.

The recent haste to shut concluding wage pension strategies to new employees means that an increasing figure of workers now have to trust on defined part ( money purchase ) schemes to supply their future retirement income, either through a strategy set up by their employer or a personal pension as a group or single agreement. Buessing and Soto ‘s ( 2006 ) analysis of informations from Department of Labor Form 5500 filings shows that the figure of persons who participate merely in a private sector define benefit program has declined from 9.6 million in 1990 to 6.6 million in 2003.

The growing of private sector define part programs has given employees new duty for pull offing retirement assets and made retirement wealth accretion a map of an employee ‘s part and plus allotment determinations. Accrued benefits in define benefit programs do non depend on fiscal market returns, except in utmost fortunes such as program insolvency. Benefits in define part programs, nevertheless, are a map of fiscal market returns. Some analysts have suggested that define part programs expose prospective retired persons to greater hazard than define benefit programs because of this nexus.

Several recent surveies have examined fiscal market hazard in define part programs. Balcer and Sahin ( 1979 ) compare define benefit and specify part programs in a lifecycle scene, acknowledging that net incomes uncertainness and occupation passages have an of import consequence on the accrued wealth of define benefit program participants. Bodie, Marcus, and Merton ( 1988 ) note that define benefit and specify part programs both entail hazards, but that these hazards are different. Neither of these surveies make quantitative estimations of comparative hazards ; two more recent surveies do. Samwick and Skinner ( 2004 ) usage informations from the 1983 and 1989 Survey of Consumer Finances and the associated Pension Provider Supplement ( PPS ) to sum up DC and DB program attributes. They generate man-made net incomes histories under the premise that the logarithm of net incomes follows a random walk with age-related impetus, and they evaluate define benefit and specify part wealth accretion for these net incomes histories. This attack may lose elusive stochastic belongingss of existent net incomes histories. The consequences suggest that for many workers define part program accretions are likely to transcend the actuarial nowadays discounted value ( PDV ) of define benefit program benefits. Finally, Schrager ( 2005 ) uses informations on net incomes and occupation alteration forms from the Panel Survey of Income Dynamics to analyze related issues. She finds that occupation turnover increased in the 1990s, doing define part programs more attractive relation to specify benefit programs for many workers. Both of the empirical surveies parameterize the net incomes and occupation alteration processes, thereby stamp downing some of the profusion in single net incomes histories.

One of the cardinal hazards in both define benefit and specify part wealth accretion is an “ antique ante ” hazard that workers face when they accept a occupation: what does the house ‘s define part or specify benefit program offer? There is significant fluctuation in the generousness of employer fiting parts in define part programs, and in the normal retirement age and degree of hazards that are realized as their working calling unfolds. These include their net incomes way, which is a cardinal input straight to specify benefit wealth accumulations and which affects the capacity to do define part parts, the economic lucks of their employer, which may take to alterations in the retirement program parametric quantities, their occupation term of office and the figure of occupations they hold over their on the job calling, the picks they make in a define part program, and the fiscal market returns that they earn on their define part program investings. Some constituents of both the post-retirement benefits in define benefit programs. In add-on to these ex ante hazards, workers besides face antique station ex ante and ex station hazard are under the control of the worker, who may make up one’s mind whether or non to work for a house with peculiar pension features, whether or non to voluntarily divide from a house with a define benefit program, or whether or non to lend the maximal sum to a define part program.


When employers try to compare the existent overall cost of supplying a typical defined benefit strategy with a typical defined part strategy, they normally fail to compare like with like. It is frequently forgotten that because employers tend to profit from favourable investing returns with defined benefit strategies, many defined benefit agreements have really cost a batch less than part degrees suggest if you take into history part decreases and part vacations.

Surely when looking back beyond the recent troubled fiscal markets, it was non uncommon for defined benefit agreements to be keeping excesss and/or to be taking part vacations. This will non be possible under a defined part strategy where the employer is required to keep the in agreement degree of parts irrespective of how good the investings are executing, capable merely to the provision that an person can non be over-funded ( i.e. the benefits that can be purchased by their parts can non transcend the maximal as laid down by the Inland Revenue ) .

This will non ever be the instance and negotiants might wish to remind employers of this fact during their deliberations. Where it does non turn out possible to carry the employer to keep a defined benefit strategy for all employees so the aim must be to guarantee that the defined part strategy agreed is basically based upon parts that will really present an equal pension for future retiring employees.


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