Employee Benefits : Defined Benefit Fund/Defined Contribution Fund

Defined Contribution Funds 

These funds are known as "money purchase" or "fixed contribution" funds. 

The rules of the fund, specify the contributions to be paid by the employer and member, but does not guarantee the retirement benefit. 

The benefits are dependent on the following factors:

• The value of contributions paid by the employer and the member.
• The performance of the underlying investments in the fund.
• Administration costs
• Allocation of withdrawal credits when other members leave.
• Prevailing annuity rates at the time the pension is taken.

Advantages of a Defined Contribution Scheme

• You could have the advantage of a higher pension at retirement than you would have received from a defined benefit retirement fund as a result of better investment performance.
• If you change employment you will be entitled to take the full benefit.
• You could have a wider choice of investments to choose from.
• Your final salary is not as important as the benefit and is not based on a formula.
• It's easier to understand defined contribution than defined benefit.

Disadvantages

• The member now takes the full investment risk.
• There are no guarantees that your pension will keep up with inflation.
• AIDS could have a big impact on the net contribution paid towards your retirement fund as the cost of group life cover could increase.
• Members have no idea what their ultimate pension will be.

Defined Benefit Scheme 

These funds are sometimes called "final salary" or "fixed benefit" funds. The benefit is normally defined according to a formula, which usually considers three factors:

• Your salary at retirement (this is often your average salary over the last two or three years of service).
• The number of years continuous membership in the fund.
• The factor or "accrual" used in the calculation.
• For example: The average salary over the last two years X number of years service X 2.2%.

Advantages 

The main advantage is that the member knows exactly what pension he will receive at retirement as a percentage of his salary close to retirement. 

You do not take the investment risks. 

Disadvantages 

There are no guarantees that your pension will keep up with inflation as increases are at the discretion of the trustees and dependant on the investment returns within the fund. 

The trustees can retain part of the investment return to build up a surplus in the fund - but this would not affect the benefit at retirement. 

Your final salary is extremely important and can have a major impact on your total benefit. 

The employer has an open ended liability with regards to his contributions. 

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