Examining Defined Benefit Schemes Including The Pension Accounting Essay

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This essay examines the pension and its main components. Moreover, it will be examined why public and private sectors are closing down their defined benefit schemes for new employees. The analysis includes the benefits of defined benefit schemes reasons of employers. And other available pension types for employees will be analysed such as defined contribution scheme, stakeholder pension scheme and moreover.


Since the beginning of the civilization, pension is important for everyone, especially for older people. Pension provides income for people who can not able to work any more. Pension is important both for employee and employer. It is obvious why important for employees who want to guarantee their retirement also important for employers to find the highly qualified, experienced or the best employee. Many people when they choose their work place, they decide according to pension plan. There are many different types of pensions in the UK. Most common three types are; State Pensions, Occupational Pensions and Personal/Individuals Pensions. Most people have at least one of them, but some people can have all three.

State pension has three fundamental elements, which are basic state pension, additional state pension and pension credit. State pension is a regular pay until the retirement age. When woman are 60, man are 65 they can claim their state pensions.

Occupational pensions are offered by employers. There are 2 main types of occupational pensions which are defined benefit schemes and defined contribution schemes.

Personal pensions are for every one under age of 75. Most of the insurance companies, investment houses and banks offer personal pension which is also long term saving.

The Defined Benefit Schemes' closing down

In recent days, many organisations are closed down their pension schemes for new employees. Therefore employers focus on defined contribution schemes to provide employees retirement incomes. According to Greenwood (2010, p.70), "From beginning of 2009, only 26% of private sector defined benefit schemes are open for new employees, according to National Association of Pension Funds survey."

Defined Benefit Scheme

In Defined benefit schemes, retirement benefits are calculated by fix formula which is related to salary or service. Therefore, employees know how much benefit they will get when they retire. The most defined benefit schemes are related to final salary which means that employees' retirement benefits depends on their last salary before they retire. The main advantage of defined benefit scheme is that provides 2/3 of final salary. And all risks are carried by employers. Taxation rules are very strict about payable amounts.

One of the most significant benefits of this scheme is that receiving either basic or higher tax refunds is controlled by this scheme which means people do not have to fill in a form during the tax year in order to claim their tax refunds whereas it seems an obligation for people who saves through either group personal or group stakeholder plans.

Nevertheless, the people who need cash in hand at a certain time of their life can accept to taking refund from their contributions, therefore, the employer will no longer add the money in contribution of employee's scheme which means the employer will not take any risk after this time and they do not have to analyse the employee's future situation in term of preparing pension plan. Futhermore, the employees will loose their tax reliefs and investment growths regard to refund they receive. (Greenwood, 2010)

Advantages for employees

Advantages for employers

Their retirement incomes can be known in advance.

All affords are provided by employers.

They do not have any investment risks related to change in stock market.

It is calculated by related to their final salary; their earlier salaries do not have any affect at all.

They have option to retire in earlier age.

Death and disability benefits are covered.

They gain employees loyalty.

Valuable workers prefer the company because of pension plan.

Additional valuable benefits can be provided.

This pension plan can be related to objectives of organization.

Employers can get higher investment returns.

Reasons of Decline in Defined Benefit Scheme

There are some reasons why employers are closing their defined benefit schemes. The main reason is an effective break down in share prices which were fall down in 2000-2003 and 2008-2009 (OPA, 2009). Another main reason which should take into account with this reason is the rise in number of people who lives longer. In defined benefit schemes, the employer is in charge of carrying most of the investment and other risks. Defined benefit schemes are getting more expensive to fund. There are many reasons which include low interest rates, increased wages (staff costs) and poor investment performance.

Accounting Standard FRS 17

Financial Reporting Standard 17 is designed to set up accounting requirements. Companies' pension scheme assets and liabilities must be demonstrated on the balance sheet. All changes must be reported properly such as growth on their liabilities for pension fund. According to OPA (2009) "These standards have been heavily criticised because they require companies to use discount rates based on AA rated bonds which is very misleading as this understates the liabilities and deficits." Also disclosing a deficit of pension scheme has a huge negative effect on companies profit. It has especially effect the companies defined benefit schemes, but not really has effect on defined contribution schemes. Therefore, employers switch their defined benefit schemes to defined contribution schemes.

Increased Costs

In our day, people live longer than used to be. The aim of the scheme is to reward employees regarding to their lifetime services. However, employers did not expect people to leave this long. According to research people leave 5 years longer than the time of defined benefit scheme was introduced. According to OPA (2009) "An extra five years is an extra one-third on the time the pension was due to be paid. That extra cost of living longer comes to around 30% on the liabilities of a typical pension." Costs increase because of reductions in values of fund and regulatory requirement.

The Pension Protection Fund

The Pensions Act of 2004 has been determined to protect members who funds and provide safe retirement, if their companies go into bankrupt. This act especially designed for defined benefit scheme. Regarding to Pension Protection Fund (2009) "This is funded by levies on the companies operating DB schemes and thus represents yet another burden which has accelerated the closure of these schemes."

Other Available Pension Schemes

In these days, many employers favour of providing a defined contribution scheme. Because defined benefit scheme is more costly and risky for employers than defined contribution scheme which still provide benefit but it depends on contributions made. There are some other alternative financial arrangements for retirement as well as defined contribution scheme, such as individual pensions.

Defined Contribution Scheme

Employers replacing defined benefit schemes to defined contribution schemes, because they can put a lower contribution. With a part of this scheme, your pension will be depends on how much you and your employer pay into a fund and also depends on your investment performance. This type of pension scheme provides more advantages than individual pensions. In Defined Contribution Scheme, money is growing quickly because both employees and employers put money together; in general employers' contribution is between 5% and 10% of wage. The annuity rate and value of the fund in the time of the retirement are important because these have an impact on pension in this scheme. In contrast to defined benefit scheme, most of the risks are in employees shoulder. If they fail to pay fix level of contribution, their benefits will be lower in retirement.

Stakeholder Pension Scheme

Stakeholder pension scheme, stakeholder pension is a part of personal pension and addition to basic state pension. Every employer which has more than 5 staff have to offer this pension scheme, unless provides a better alternative. It is easy to be member of this scheme which is flexible to start or cancel a scheme any time. Stakeholder scheme provides many advantages such as low minimum requirement (£20 a month).

Group Personal Pension Scheme

Another type of pension which is getting more popular since decline on providing defined benefit scheme is group personal pension scheme. This scheme is a bundle of personal pension scheme. Contribution can be made by both employees and employers but contribution is not compulsory for employers. It provides opportunity to take a tax-free lump sum at retirement.

Shared Risk Scheme

According to ACA (2007) Pension trends survey report shows that "defined contribution schemes too volatile in terms of what they may deliver, the case for offering a 'third way' whereby both employers and employees can take advantage of the opportunities to provide cost-effective and more certain pensions through new risk sharing arrangements". Shared risk schemes will provide advantage for both employees and employers. It aims to share risks rather than leaving the risks completely to employees and employers shoulders.


To sum up, employers have right to close down defined benefit scheme to new members. As we mentioned above, they have many reasons because of risks. Closing down defined benefit scheme reduces employers' risks and employees' advantage. However, they both still get benefit from other pension schemes. To give an example, Defined contribution scheme is more flexible than defined benefit scheme. Also there is low risk for employers. It is quiet difficult to compare these schemes because these all have different advantages and disadvantages.