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Defined Benefit And Define Contribution Pension Strategies Accounting Essay

Pension is fund that is built through the working life of the staff and then used to secure the income after retirement life. These funds can be run by workplace (occupational pension) who invests as time passes or alternatively worker can invest in a fund of these choice (private pension system). Both of these schemes generate income after retirement life.

The pension funds are handled in many countries. Regarding to international financial service the UK pension account is $1, 464 billion, Germany experienced $268 billion and France got $164 billion.

Pension techniques are of two major types:

Defined benefit scheme

Defined contribution scheme


Define benefit design is also called final salary plan which stipulate a specific degree of income after old age normally based on final salary and amount of service. Although there's a compulsory contribution by the employee, most of the price tag on the benefit and threat of the investment is borne by the company.

For example, in most of the general public sector pension strategies, UK employers pay 60% of the price of providing the benefits and associates pay 40%.

Various factors which influence the contribution includes:

Value of the structure assets and investment produce.

The structure of scheme regular membership.

Rate of salary expansion of the scheme members.

Longer life span after retirement living.

Changing regulatory requirements.

Contributory Defined Profit Scheme:

In this case the employees make contributions to the pension design. Final Salary Plans and Profession Average Salary Strategies are the contributory Defined Advantage Schemes.

Final Salary System: In cases like this the pension amount is calculated on the basis of the final salary of an employee in that company. From your employer's viewpoint they are expensive as compared to other pension techniques. The contributions for are made by the employee for the pension plan.

Career Average Salary Program : It calculates the pension amount depending upon the average earnings over the total number of years a worker works in a corporation. The benefits would be a percentage of the common salary received by an employee during his profession in that particular company. As compared to final salary program they are less expensive for the employers. In this case also employee contributes in the pension scheme.

Non- Contributory Identified Benefit Design: In cases like this the emploer rather than employee is in charge of the efforts in the pension system. Cash Salary Structure is the non contributory Scheme.

Cash Salary Plan: That is a non contributory defined benefit scheme. In this case employer contributes a specific amount of money each year on behalf of the employee. These are a mixture of defined gain scheme and described contribution scheme. Because of this also, they are called as Crossbreed Schemes.

Decline in Defined Profit Schemes:

In define profit scheme company bears the majority of the chance as well if the pension account become inadequate either anticipated to poor investment performance or large salary boosts, workplace must replenish the pension account out of business revenues. Operating such structure on average earnings rather than last salary can help protect against higher level of salary development.

Munnell and Soto found that many businesses have "frozen" define gain ideas since 2003. You can find Following are the number of factors which were used by employers to describe the decrease of defined advantage schemes which can be described below:

Source : http://www. opalliance. org. uk/decline. htm


Defined contribution plans are also known as money purchase structure in which the employee and/or company make contributions into a pension fund according to prescribed rules. At pension the pension fund is used to buy annuity which can be an income guaranteed for life of the receiver. A lot of the personal pensions are of his type. Under defined contribution schemes pursuing factors determine the pension income available at retirement.

The contributions committed to the plan;

Product supplier charges;

The performance of the pension account;

The annuity rate at retirement date

The main factors that determine the huge benefits at retirement will be the contributions spent by the employee, the return on investment attained, Annuity rate, the type of annuity picked and the charges of the system. Due to the characteristics and great things about this scheme, this is the most popular pension plan schemes used in UK. These efforts cover a wide variety of private and occupational strategies. In this case the risk of poor dividends on investment or high cost lays with the employee instead of workplace. The employees cannot forecast their pension as the profits on return finance is uncertain. The factors influencing the return like annuity rate, charges on assets and performance of investments are beyond the control of the staff. An employee can also be certain of the quantity of investment made by him. In the initial periods of investment the contributions are invested in the investments where risk is high so when an employee reaches near his retirement life his efforts are invested in relatively less riskier ventures. This provides a good combo of expansion and security. Employees in cases like this can have taxes relief on their contributions.

The pension account in cases like this therefore includes:

Pension Account = Employee's Contributions + Employer's Contributions + Investment Profits + Tax benefits

The contributions are invested in the stocks and other purchases with the purpose of earning more return on these ventures which can assist in the development of the pension fund before the retirement of the employees. Employees can make the investments where they want to invest. At the time of retirement employees may take a tax free lump total amount off their pension and the rest of the amount may be used to secure an income.

If a worker changes his job he can stop making payments to his fund and can leave it as it has been his previous employer. This is also known as Deferred or Preserved Pension. Usually with some additional expense and risk he is able to get it transferred to his new employer or a stakeholder.

Defined contributions structure allows employees to make regular efforts. Company can also choose for making contributions in the pension finance.


The defined advantage and defined contribution schemes can be best differentiated by identifying where the risks lie.

In a defined benefit program, the workplace bears the vast majority of costs and when investment earnings poor deliver or costs increase, the pension account can become insufficient and the employer must replenish the account out of the business income.

Whereas in a precise contribution plan the efforts are paid at a fixed level and for that reason it's the recipient who bears these risks. If they're not able to increase contributions when finance performance is poor or cost rises, then their retirement life income will be lower.

In UK there is an upper limit from a define profit scheme while there is no top limit to the amount of income generated from this scheme.


Defined Advantage Scheme

Defined Contribuion Scheme



Risk sits with the employer

Risk is placed with the employee


Change in Value of Investment

Pension finance is set and pre determined.

Pension funds hold the growth potential. They may be flexible and can provide more go back.


Affect of Market conditions

Market conditions do not affect the pension fund

Market conditions influence the come back on investments made by the employees.


Economic Conditions.

Economic conditions like inflation, influences the employees. Because they receive set amount and the worthiness of money decreases.

They have less impact of the economic conditions on the ventures.


Cost to employer

These have high cost associated with them for the workplace.

These plans have comparatively low cost.



Responsibility to make payments lay with the company most of the changing times.

Employee is accountable to make payments



These pension plans have a downward development these days because of the cost associated with them for the workplace.

They produce an upward trend because of the less cost to the employers.



These are relatively more certain. The same amount invested by two different individuals supplies the same return.

These are uncertain in aspect. The employee is aware the total amount he or his employer invested but he is uncertain about the go back on this investment.

The recent rush to close final salary pension schemes to new employees means an increasing number of workers will have to count on defined contribution (money purchase) techniques to provide their future retirement life income, either through a structure set up by their company or an individual pension as an organization or individual set up. Buessing and Soto's (2006) research of data from Department of Labor Form 5500 filings shows that the amount of individuals who get involved only in an exclusive sector define gain plan has declined from 9. 6 million in 1990 to 6. 6 million in 2003.

The growth of private sector define contribution strategies has given employees new responsibility for handling retirement assets and made retirement life wealth deposition a function of employee's contribution and advantage allocation decisions. Accrued benefits in define advantage ideas do not be based upon financial market dividends, except in extreme circumstances such as plan insolvency. Benefits in define contribution plans, however, are a function of financial market results. Some analysts have suggested that define contribution designs expose potential retirees to increased risk than define benefit plans for this reason link.

Several recent studies have analyzed financial market risk in define contribution ideas. Balcer and Sahin (1979) compare define profit and define contribution programs in a lifecycle setting up, recognizing that profits uncertainty and job transitions offer an important influence on the accumulated wealth of define profit plan members. Bodie, Marcus, and Merton (1988) note that define advantage and define contribution packages both entail dangers, but that these risks will vary. Neither of the studies make quantitative estimates of relative hazards; two newer studies do. Samwick and Skinner (2004) use data from the 1983 and 1989 Study of Consumer Budget and the associated Pension Supplier Supplement (PPS) to conclude DC and DB plan attributes. They generate man-made cash flow histories under the assumption that the logarithm of revenue follows a random walk with age-related drift, plus they evaluate define advantage and define contribution prosperity deposition for these cash flow histories. This approach may miss delicate stochastic properties of actual earnings histories. The results suggest that for many staff explain contribution plan accumulations are likely to go over the actuarial present low priced value (PDV) of define profit plan benefits. Finally, Schrager (2005) uses data on earnings and job change patterns from the -panel Review of Income Dynamics to study related issues. She sees that job turnover increased in the 1990s, making define contribution packages more attractive relative to define benefit strategies for many individuals. Both of the empirical studies parameterize the wages and job change functions, thereby suppressing some of the richness in individual earnings histories.

One of the key hazards in both define advantage and define contribution riches accumulation is an "ex girlfriend or boyfriend ante" risk that personnel face when they allow employment: what does indeed the firm's define contribution or define benefit plan offer? There exists substantial variant in the generosity of workplace matching efforts in define contribution plans, and in the standard retirement age and level of dangers that are understood as their working career unfolds. Included in these are their earnings journey, which is a key input right to define benefit riches accruals and which affects the capability to make define contribution contributions, the economic fortunes of the employer, which might lead to changes in the retirement plan parameters, their job tenure and the amount of jobs they maintain over their working career, the choices they make in a define contribution plan, and the financial market profits that they earn on their define contribution plan assets. Some components of both post-retirement benefits in define profit plans. In addition to these ex ante dangers, workers also face former mate post ex lover ante and ex lover post risk are under the control of the staff member, who may make a decision if to work for a company with particular pension characteristics, whether or not to voluntarily distinguish from a firm with a define advantage plan, or whether or not to contribute the utmost total a define contribution plan.


When employers make an effort to compare the true overall cost of providing a typical defined benefit program with a typical defined contribution structure, they usually fail to compare as with like. It is often overlooked that because employers have a tendency to benefit from favorable investment earnings with defined benefit schemes, many described benefit plans have actually are expensive significantly less than contribution levels suggest invest the into consideration contribution reductions and contribution getaways.

Certainly when looking back again beyond the recent troubled financial market segments, it had not been uncommon for identified benefit plans to be having surpluses and/or to be taking contribution getaways. This will not be possible under a defined contribution scheme where in fact the employer must maintain the agreed level of contributions regardless of how well the investment funds are performing, subject matter and then the proviso an individual cannot be over-funded (i. e. the benefits that can be purchased by their efforts cannot exceed the utmost as laid down by the Inland Revenue).

This will not always be the truth and negotiators might prefer to remind employers of this fact during their deliberations. Where it does not show possible to persuade the workplace to maintain a precise benefit scheme for everyone employees then your aim must be to ensure that the identified contribution system agreed is essentially based upon contributions that will actually deliver an satisfactory pension for future retiring employees.

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