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The defined benefit plan of pension in the UK is a plan of pension for the employee that is provided by the employers after the retirement (Types of private pensions – GOV.UK, 2016). The scheme is investment free for the employees. The benefit from the employers is depended on the period of employment and salary drawn every month. It is a promise from the employer to the employee to pay a certain amount every year after his/her retirement. According to Babatunde (2012), the benefit plan provides the employees an advantage of getting a percentage from the employers’ profit after their retirement. It also helps them to improve their lifestyle after retirement.
In the UK, the benefit pension plan is indexed with the consumer price index. The available index in the market for retail price is the basis of measuring the pension for future to adjust the purchasing power of the retiree people. In this way, the employees in the UK may get their defined benefit pension at higher rate in line with the increase in CPI. The scheme is suitable for the retirees as they may take free cash lump sum after their retirement. Further, it is also a well-known fact that current income of the employees must be high enough for getting the higher pension. The scheme is suitable for the employees who select an employer for long duration. Thereby, the employees may see the volatility in the pension fund due to change in the salary as well as period of association with the scheme. However, Woods (2015) found that income from the pension is taxable income for the retired person.
Defined contribution plan may provide an employee the chance of contributing in his/her pension fund from his/her salary. The scheme allows the employees to save from their salary for this fund. The employers normally provide an equal or more of the portion for the contribution plan than the employees contribute from their monthly salary. The fund in contribution plan is depended on the payment made by the employees and the employers (Types of private pensions – GOV.UK, 2016). This is a good option for the employees with high salary who may opt for high value of sacrifice in the pension funds monthly. However, the created funds are invested in different types of instruments like shares and other bonds. Therefore, the risk associated with this fund is higher than that of the benefit scheme of pension (PORTEOUS, TAPADAR and YANG 2012). This plan does not provide any guarantee to the employees after their retirement. Additionally, the employees have to pay for this plan from their salary. They also do not get any benefit from their employers directly for managing the funds. The 25% of the funds is non-taxable and can be redeemed after the retirement. The pension can be achieved from the fund after the retirement at an age of 65 normally. However, the employees are entitled to get their pension after 55 of their age. In this case, it may reduce the pension income per month for them (FT.com 2016).
The major difference between the two funds is the risk and return associated with the funds and future value of the pension. In this regard, HUGHES (2011) found that pension from the defined scheme has the risk of bankruptcy of the employers or the entity after retiring from the company. But, if the balance sheet of the company is good, then the employers may get the pension as per the agreed value. The contribution scheme is entirely depended on the market performance of the financial instruments (Babatunde 2012). For the last fifteen years, the performance of benefit scheme is better than the contribution scheme (Defined benefit pension schemes explained 2016). The volatility in the financial market as well as in the economy may have touched the bottom of the contribution funds. The risk associated with the defined benefit plan is too high as the news has released in the newspapers in past days (FT.com 2016). The deficit of this scheme is too high such as 600 in numbers for defined benefit scheme. The scheme has made the funds sunk in debt to pay the entire amount of the pension per month.
References: Report on defined benefit pension plan essay
ft.com, 2016. Closure looms for hundreds of defined benefit pension schemes – FT.com. [online] Financial Times. Available at: <http://www.ft.com/cms/s/0/afdb6442-2701-11e5-bd83-71cb60e8f08c.html#axzz41yK5nLcw> [Accessed 4 Mar. 2016].
Moneyadviceservice.org.uk, 2016. Defined benefit pension schemes explained. [online] Moneyadviceservice.org.uk. Available at: <https://www.moneyadviceservice.org.uk/en/articles/defined-benefit-schemes> [Accessed 4 Mar. 2016].
gov.uk. Types of private pensions – GOV.UK. [online] Gov.uk. Available at: <https://www.gov.uk/pension-types> [Accessed 4 Mar. 2016].
ft.com. 1,000 defined benefit pension plans ‘unlikely’ to pay in full – FT.com. [online] Financial Times. Available at: <http://www.ft.com/intl/cms/s/0/80a113e6-9fdf-11e5-beba-5e33e2b79e46.html#axzz41yK5nLcw> [Accessed 4 Mar. 2016].
Babatunde, M., 2012. The Impact of Contributory Pension Scheme on Workers’ Savings in Nigeria. The Social Sciences, 7(3), pp.464-470.
HUGHES, G., 2011. Pension costs and liabilities for UK-regulated utilities. Journal of Pension Economics and Finance, 11(01), pp.89-117.
PORTEOUS, B., TAPADAR, P. and YANG, W., 2012. Economic capital for defined benefit pension schemes: An application to the UK Universities Superannuation Scheme. Journal of Pension Economics and Finance, 11(04), pp.471-499.
Woods, J., 2015. On the political economy of UK pension scheme regulation. Cambridge Journal of Economics, p.bev048.
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