What You Need To Know About the Defined Benefit Scheme
A Defined Pension Scheme is a pension scheme which defines the benefits to be paid to the members on retirement. These traditional company schemes allow employees to accrue pension benefits based on their length of service with the company.
The defined pension that an employee will receive when they retire or leave the company is based on final salary or, the average earnings during the last few years of service. The risk of the final salary defined benefit pension scheme lies with the employer and their commitment to deliver a pension to the departing employee, regardless of return on investment.
Types of Defined Benefit Schemes
There are two main types of Defined Benefit Schemes:
- Contributory Defined Benefit Scheme - The employee will make regular pre-tax contributions. These contributions are often matched by employers, greatly benefiting the employee.
- Non-Contributory Defined Benefit Scheme - The employer will make contributions on behalf of the employee, who does not contribute to the pension.
The benefits of Defined Benefit Schemes
In many cases, Defined Benefit Schemes are extremely favourable to the employee; however, the length of service and final salary will determine how favourable. The benefits of the Defined Benefits Schemes may include:
- A lump sum cash payment and an income for life
- Life insurance and a pension for a spouse if they no longer live with you
- A commitment by the employer to deliver a pension. The employer must decide on how much to invest and where to put it, they will also need to monitor investment progress and make decisions on the amount of contributions being made.
- A set rate of contributions is deducted from the salary of the employer (before tax) each month
Some Defined Benefit Scheme Top-Tips
- Many Defined Pension Schemes exclude bonuses and overtime from a salary when calculating a final pension payment. Ensure that you thoroughly establish how your salary is defined.
- Establish the accrual rate for your scheme.
- Consider whether it is financially viable for you to make additional contributions within the Defined Benefit Scheme.
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