Distinguish Between Defined-Benefit and Defined-Contribution Pension Schemes.Why Are Defined-Contribution Pension Schemes Becoming More Important?

Distinguish between defined-benefit and defined-contribution pension schemes. Why are defined-contribution pension schemes becoming more important?

Currently retirement is alike baby boomers, public pay more attention on how to make your “nest egg” last (White, J.B.et al. 2011). Have a good retirement, can guarantee the staff to a normal life after retirement, is not only beneficial to a country's social stability will also help a country's economy.So the topic of providing appropriate pension is an increasing considerable interest recently (Ezra 2007). Pension is conducive to social stability with the arrival of an aging population, and the elder takes high proportion of the population increases. Only the sound and perfect pension insurance could protect the basic living of older workers, equal protection of the basic life of citizens.

 The pension is a dominant section of the institutional investment. The investors  always save the money when they are working and invest funds into the institutional investment to build the pension funds .When the fund used to finance, then the income will pay it when the investor at the age of retirement. It is optional to individuals to choose, the pension fund could be built by companies or the employees. Stocks and bonds are the most important portfolio according to pension investment. Each country pays different attention on the pension, the government funding for pension level is different also. IFSL showed that UK spent about $1,464 billion in pension nevertheless Germany occupied around $268 billion and France $164billion. Compared the pension funds in France and Germany, the mount of the pension are more than it in 2001(Redhead 2008). Our objective in this essay is to distinguish the differences between defined benefit pension (DB) and defined contribution pension (DC), and explain the reason why the defined-contribution pension are becoming more and more important.

Pensions are usually divided into two kinds, one kind is defined benefit and another one is defined contribution pension. Under the defined benefit plans, the annual pensions are usually provided by employers. Under the pension plan the employees’ retired incomes have already been stipulated. The defined-benefit pension actually depends on length of service and final-salary. For example how to calculate the pension income, Mr. K employee retires after 50 years of work with a final salary of £60,000,in a pension plan based on 1/60th salary. The he could get 50×(£60,000/60)=£50,000. As for the advantage of the DB pension plans, it could be independent of the inflation and the market performance, it is good to high income and service for long period staffs, this means that they could remain the high level pension. Disadvantage is that the expensive employee pension is defined by the employer. A non-government defined –benefit pension schemes is possible not provide the appropriate funding. Moreover some DB pension if the beneficiary died, only allow part of the pension is transferred to partner. Compared with RRSP, where all property could transfer. (Redhead 2008)

Defined contribution pension plans do not include a fixed income when retirement, instead, it supplies the contribution fund to invest portfolio performance, these money usually come from employer. How much you will receive the pension income it based on the portfolio return. The pension funds usually invest the annuity or drawdown. Pension acquire largely depends on the growth ratio of the fund and the annuity rates during retirement. As the smart investor usually allocates the money into different project, so could gain big size profit as the pension. We can sum up there are some merit and demerit of DC pension plan can distinguish it from DB pension plan. As for the merit of the scheme, employee can not only control your investment plan but also witness how your income grows. There are also some shortcomings about the scheme. The most pension funds are used in the stock markets. Hence, there could be considerable uncertainty according to the future size of value in pension. The stock market exist many factors affect the pension system stability. If government bonds revenue is lower than it at the time of retirement, annuity rate is low. And the market performance in the invested period could affect the retired income. As we all known that not all the employee are interested in finance, they have to be related with the financial investment. (Redhead 2008)

Under the DB pension plan, the employer will take many risks, which involve the passive market performance, bad fund management, decrease government bonds revenue, rising wages and the extension of life span. In this case, the employer must refill the pension fund out of the employers’ operate yield when the employ cannot meet the promise. In addition, in DC pension plans it is related with the person who should take the risk related to investment return and annual rate (Redhead 2008).

The defined benefited pension played a main role in the past few years. However the defined-contribution increasing accounts the majority of the pension system today. The chart 1 illustrates the trend that the DC pension is lead increasing trend in US during 1985 to 2002. The reason of this maybe DC pension system is more sustainable to the nowadays society. As we can see that the increases in lifespan could increase the pension debt, at the same time the declining birth ratio will less the contribution (Cocco and Lopes 2011) .There is a general trend that the defined benefit pension will transfer to defined contribution pension scheme according to US in the past twenty years (Chen 2006). Since the employers would like to avoid the risk, so they usually move to defined contribution pension plans. In addition, the worker changes the work more frequently than before, because the employee can take the pension fun with when they choose the DC pension scheme. The defined contribution pension scheme is much easier than the defined benefit pension to calculate the pension to employer and employee. In DC pension plan, we could use the below endowment equation to calculate the pension , it is efficient and easy. The equation to estimate the total sum from regular investment is: M = p [(1+y) T - 1] / y, it is meanings that a gross payment of £p per year at an average investment return of y per year for T year produces a final investment value of £M, which is used to buy an annuity or is drawn down over time. Annuity is the guarantee of the pension income. Once the annuity is bought, it cannot refund, so the annuity could regard as the investment. So the investment could also have the gainers or the loser, it depends the longevity. Annuities normally could be invested in government bonds. The benefit comes from pension fund is free tax (Redhead 2008). The cost of the pension investment could return the income to the pensioner during the time of they are retired. The size of pension depends on the annuity, when the annuity ratio is low the income pension is low .While the annuity depends upon the yield of the government bonds. The revenue of the bonds is vary indifferent years.