They can be in the form of a guaranteed annuity or a cash balance that an employee can draw upon at retirement. A pension that is created by an employer for an employee is known as an occupational pension. The government or other organisations may also sponsor pensions. Pension plans are a form of deferred compensation.
The United Kingdom pension system is characterised by three tiers. The first tier is that of Basic State Pension (BSP) which is provided by the state. There are several pension schemes in the second tier. The state, employers, or private sector financial institutions provide these schemes. These pension schemes may be divided into two broad types: Defined Benefit (DB) pension schemes, and Defined Contributions pension scheme (DC). The DB schemes include the State-Earning-Related-Pension Scheme (SERPS), and occupational pension schemes provided by employers. The DC schemes include the contribution pension schemes offered by employers, and the personal pension, or a stakeholder pension fund held with a financial institution. The third tier of UK's pension system is voluntary and it takes the form of additional voluntary contributions (AVCs and FSAVCs) into occupational or personal pension schemes.
The pension schemes we need to focus on behalf of the company are occupational pension schemes. ...
In the DB pension scheme, the retirement pension benefits are related to the member's final salary upon retirement, and length of service. This is a "funded" plan in which both employer and employee contribute towards the pension fund. A DC pension scheme is a scheme that provides an individual account for each employee participant. The benefits are solely on the amount contributed to the account, gains, expenses and losses allocated to the account. The plan contributions, which are fixed for both the employer and employee, are paid into the account for each member. These contributions are invested and the returns are also credited to the individual's account. On retirement, the member's account is used to provide retirement benefits. This is usually through the purchase of an annuity that provides regular income post retirement. The members also have the option to draw a certain lumpsum amount before purchasing annuities. These plans also may offer the facility to members to select the types of investments towards which the pension funds would be allocated.
Relative Merits of DB and DC Schemes
The contributions in case of DB schemes are higher to keep up with the cost of providing the defined retirement benefits. It is even higher for employers relative to employees.
DB plans offer less mobility than the DC plans because the transfer costs and difficulty in transfer of funds is very high for the DB Plans. DC plans offer higher portability.
Both the DB and DC plans offer tax relief on contributions to employers. Tax relief is usually higher in case of DB plans due to higher contributions.
Unlike the DB schemes, in a DC scheme a member cannot predict his pension at the time of retirement, as it is difficult to predict what capital he will accumulate