What is a DB Scheme?
A DB Scheme (Defined-Benefit Pension Scheme) is a type of retirement plan where the employer commits to provide retirees with a specific, predetermined benefit based on factors such as salary history and duration of employment. The employer bears the investment risk and is responsible for providing the defined benefits irrespective of the fund’s performance.
Key Characteristics
- Guarantee: Employees receive a guaranteed payout at retirement.
- Calculation: Benefits are calculated using a predefined formula, often based on salary and years of service.
- Employer Responsibility: The employer is responsible for ensuring the pension fund is adequately funded to meet future obligations.
Examples
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Example 1: Final Salary Plan
- A company offers a final salary pension scheme where employees are entitled to receive an annual pension based on the average of their final five years of salary and their years of service.
- An employee with a final average salary of $80,000 and 30 years of service might receive a pension of 1.5% of their salary for each year of service: 30 x 1.5% x $80,000 = $36,000 annually.
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Example 2: Career Average Plan
- Another firm’s pension scheme might use a career-average formula.
- An employee earning an average salary of $60,000 over their career with the same firm for 25 years might have a pension formula offering 1.2% of career average salary per year of service: 25 x 1.2% x $60,000 = $18,000 annually.
Frequently Asked Questions
Q: What is the main difference between a DB Scheme and a Defined-Contribution (DC) Scheme? A: In a DB Scheme, the employer guarantees a certain payout upon retirement, bearing the investment risk. In a DC Scheme, the contributions are defined, and the retirement benefit varies based on investment performance, with the employee typically bearing the investment risk.
Q: How does a DB Scheme manage investment risks? A: The employer manages the investments and absorbs the risks. They must ensure the pension fund is sufficiently funded to meet future obligations through ongoing contributions and effective investment strategies.
Q: Can an employee lose their benefits in a DB Scheme? A: Employees typically do not lose their benefits, given the employer’s obligation to fund the scheme. However, if an employer faces financial difficulties or bankruptcy, pension payments might be affected, potentially covered by pension insurance funds depending on legislation in the country.
Q: Is it possible to transfer pension rights in a DB Scheme? A: In some countries, employees can transfer accrued pension rights if they move to another employer with a comparable scheme, though this may result in adjustments to benefits.
Q: How are DB Scheme benefits taxed? A: Pension payments from a DB Scheme are generally taxed as income when they are received by the retiree, akin to regular earnings.
Related Terms
Defined Contribution (DC) Scheme: A retirement plan where the amount of the employer’s annual contribution is specified, but the future benefit varies based on investment returns.
Vesting: The process by which an employee accrues non-forfeitable rights over employer-provided pension benefits, ensuring they receive benefits when they leave the company after a minimum service period.
Pension Fund: The pool of funds collected from employer and employee contributions, invested to generate income and used to pay out pensions.
Actuary: A professional who assesses financial risks in the DB Scheme, determining the necessary contributions and funding strategies to ensure the plan’s solvency.
Online References
- Pension Benefit Guaranty Corporation (PBGC) - US government agency that protects the retirement incomes of more than 35 million American workers in private-sector defined benefit pension plans.
- The Pensions Regulator - UK regulator providing guidance for trustees, employers, and administrators of pension schemes.
Suggested Books
- “Pension Mathematics with Numerical Illustrations” by Howard E. Winklevoss. A comprehensive guide on the mathematical foundations behind pension plans.
- “Understanding Actuarial Practice” by Stuart A. Klugman, Harry H. Panjer, and Gordon E. Willmot. Essential for understanding the actuarial principles applied to pension schemes.
- “The Handbook of Pension Mathematic” by Benjamin B. Rand. Offers insights into the mathematical models used for pension calculations.
Accounting Basics: “DB Scheme (Defined-Benefit Pension Scheme)” Fundamentals Quiz
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