What is a Defined-Benefit Pension Scheme?
A defined-benefit pension scheme (DB scheme) is an occupational pension scheme in which the retirement benefits to be received by employees are specified by the plan’s rules. These benefits are generally calculated based on a formula that incorporates the employee’s years of service and salary levels. Companies fund these plans accordingly, ensuring that the predetermined benefits can be paid upon the employee’s retirement.
Examples
- Final Salary Scheme: A common type of DB scheme where the retirement benefit is calculated based on the employee’s salary at the time of retirement and the number of years they have worked for the company.
- Career Average Revalued Earnings (CARE) Scheme: An alternative type of DB scheme where the retirement benefits are based on the average of the employee’s earnings throughout their career, adjusted for inflation.
Frequently Asked Questions (FAQ)
Q1: How is a defined-benefit pension different from a defined-contribution pension?
A defined-benefit pension guarantees a specific payout at retirement, while a defined-contribution pension depends on the contributions made and the investment performance of those contributions.
Q2: Why are companies closing defined-benefit pension schemes?
Rising costs associated with funding these schemes have led many companies to close their existing DB schemes to new employees, who are then required to join defined-contribution pension schemes.
Q3: How are pension costs accounted for in defined-benefit pension schemes?
Pension costs are accounted for according to the regulations set out in Section 28 of the Financial Reporting Standard applicable in the UK and Republic of Ireland, and International Accounting Standard (IAS) 19 for Employee Benefits.
Q4: What are the main components of the pension formula in a DB scheme?
The main components typically include the employee’s years of service and their final or career-average salary.
Q5: Are the benefits from a defined-benefit pension scheme adjusted for inflation?
It depends on the specific scheme. Some DB pensions include provisions for inflation adjustment, while others may not.
Related Terms
- Final Salary Scheme: A type of defined-benefit pension plan where the retirement benefit is influenced by the employee’s salary at the time of retirement.
- Defined-Contribution Pension Scheme: A pension plan where the retirement benefits are based on the contributions made and the performance of the investments chosen.
- IAS 19: International Accounting Standard 19, which provides guidance on accounting for employee benefits, including post-employment benefits like pensions.
Online References
- Investopedia: Defined-Benefit Plan
- The Pensions Regulator: Defined Benefit Schemes
- IFRS: IAS 19 Employee Benefits
Suggested Books for Further Studies
- “Fundamentals of Corporate Finance” by Stephen A. Ross, Randolph W. Westerfield, Bradford D. Jordan - Provides comprehensive insights into finance, including pension schemes.
- “Accounting for Pensions: The New Challenges” by Richard Brealey and Stewart Myers - Focused on understanding the complexities of pension accounting.
- “Pension Finance: Putting the Risks and Costs of Defined Benefit Plans Back Under Your Control” by Nigel Hawkins - Explores managing defined-benefit pension plans intentionally.
Accounting Basics: “Defined-Benefit Pension Scheme” Fundamentals Quiz
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