Oct 31, 2010


The major philosophical difference between a defined benefit (final salary) scheme and a defined contribution (money purchase) was mentioned earlier. Moving from final salary to defined contribution provision shifts all of the risk from the employer to the employees.
Add a note hereFor this reason, many commentators now advocate 'hybrid schemes' that seek to split the risk between both parties. Some employers have started to adopt such designs, and examples include the following:
§  Add a note hereCareer revalued average salary scheme. This is a type of defined benefit scheme. Instead of pension being based on final salary, the employee receives a pension proportional to service and career average salary, with salary from earlier years revalued by RPI (say).
§  Add a note hereCombined final salary/defined contribution scheme. Under this approach, both types of scheme are in operation. A final salary scheme might be provided for staff who meet an age and/or service qualification, with defined contribution provision applying to other staff. For example, membership of the final salary scheme might be limited to staff aged 40 or more, with no backdating of service; pension in respect of previous service would be provided on a defined contribution basis.
§  Add a note hereCash balance scheme. Employees are provided with a guaranteed individual retirement fund proportional to service and final or average salary. As in a defined contribution scheme, a proportion may be taken as cash with the balance being used to buy an annuity.
§  Add a note hereSchemes with an element of discretion. Low-level guaranteed benefits are provided, perhaps on a final salary or career average basis. However, there is discretion to provide enhanced pensions as and when the scheme's funding position allows it. A variant of this approach is to operate a defined contribution scheme with a modest final salary (or career average salary) guarantee.
§  Add a note hereCapped final salary. A self-imposed cap is applied to pensionable salary with defined contribution provision on the excess salary. The logic here is that it is reasonable to transfer some risk to the employee once a basic level of guaranteed retirement income has been built up.
§  Add a note hereReduced cost final salary. This is not strictly a hybrid scheme, but has been adopted in a number of companies. This approach involves retaining final salary provision but with some benefits scaled back to restrain costs. For example, some have reduced the accrual rate from 1/60th per year of service to 1/80th or, more commonly, have increased employee contributions. Often employees and unions prefer this to a move towards defined contribution provision.


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