Defined Benefit Schemes

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What is a defined benefit scheme?

When we talk about a 'benefit' we are generally talking about pensions. A benefit is really just another way of describing either of a pension or cash amount or some other sort of reward. If for example you get free dental care at work that might be described as a 'dental benefit'. If your spouse gets a lump sum on your death this might be described as a 'death benefit'. A pension might be described as a 'retirement benefit'.

A Defined Benefit (DB) Scheme is exactly that, a pension scheme where the benefit (i.e. the pension in most cases) is 'defined' in some way. Therefore it may be helpful to think of this as a "Defined Pension" Scheme. This means the pension you get is based on some sort of formula, normally related to salary and service. One quite popular kind of defined benefit scheme is known as a Final Salary scheme. In this sort of scheme a member may be promised a pension of say 1/60th of salary at retirement for each year of service. Note how the pension promised is in no way related to the amount of money put in. In a defined benefit scheme the focus is on the pension not on the contributions paid.

The above is just an example to show what is meant by a Defined Benefit scheme. The essential thing to remember is that in a Defined Benefit scheme the amount of pension (or sometimes cash) available at retirement is defined by a formula usually related to salary and service.

Defined benefit schemes come in many different guises and it is not always obvious if your scheme is defined benefit or not. However the defining quality of a DB scheme is that what gets promised is the level of pension rather than the level of the contributions. If you are in a pension scheme and the Scheme booklet does not talk about the level of contributions the employer pays (except perhaps to note that the employer pays whatever the balance of the cost is after the member contributions) chances are it is a defined benefit scheme.

You will quite often read that defined benefit is just another name for 'Final Salary'. This is simply not true. Final Salary schemes are just one type of defined benefit scheme. However that said the majority of defined benefit schemes are Final Salary schemes although we are slowly seeing a greater proportion of other types of defined benefit schemes. In this section we explore defined benefit schemes in greater detail, including an explanation of the main types of defined benefit scheme and some other invaluable stuff you need to know about your company pension.