Earlier Direct Benefit Pension schemes were considered lucrative for employees for many reasons. The most significant ones have defined old age pension benefits and financial security. However, the perception has changed over time with Defined contribution schemes and hybrid schemes.
Still, many members consider the DB scheme the best option for them. So, to simplify things, this comprehensive guide touches on every pros and cons of the DB scheme you need to know.
What is a Defined Benefit pension scheme?
As the name suggests, a Defined Benefit Pension Scheme in Ireland is a pension plan by a company/employer that promises a definite lump sum, pension payment, or a combination of both on retirement. The value of a pension depends on the employees:
- Length of service
- Salary drawn
Unlike other pension schemes, a member does not need to contribute to the DB scheme. Instead, the employer sets it up as an occupational pension scheme. In 2016, legislation was introduced to make terms and conditions of transferring the DB scheme to a new pension arrangement more flexible.
To compensate members for transferring their rights and value from a DB scheme to a private pension arrangement, a once-off cash value is offered, known as Enhanced Transfer Value. Generally, Defined Benefit transfer values range from 20-30 times your DB in retirement.
How is Direct Benefit Pension Calculated?
Although the pension is specified in a DB scheme, the exact amount is not possible to calculate in advance, as you can’t predict:
- Your future salary
- Your longevity
- Future of your employer
On average, employers pay a Direct benefit between 1/50th to 1/60th of final earnings for the period of employment. So, for instance, an employee who has been a member of the DB scheme for 50 years would receive 50/60th (5/6th) of their final earnings on retirement.
However, it is important to note that the benefits of this scheme are not guaranteed. For example, your benefits may be reduced if your employer goes bankrupt.
Pros and Cons of Direct Benefit Scheme
- Retirement income is guaranteed: This is a much more stable benefit as your employer guarantees to pay the set retirement income even when the underlying investments don’t perform well.
- Chances of retirement incomes to be guaranteed for life: Although some DB pension schemes pay for set years, others pay out their retirees for their lifetime.
- Retirement income is associated with inflation: The DB pension scheme is often guaranteed to rise with inflation. Otherwise, it certainly rises to a predetermined amount to compensate for the rising inflation.
- Employees don’t have to make contributions: Every contribution is taken care of by the employer. It leaves the employees with a good sum of money at the month end to invest in a personal pension.
- Your next of kin receives a portion of retirement income after your death: If you wish to leave your next kin some sort of financial security, the DB pension scheme is certainly for you.
- Employees don’t have control over investments: The employer manages these schemes, and they could see growth at a slower rate. It further influences the pension income the employee will receive on retirement.
- Drawdown options are rigid: It pays a set pension income monthly.
- When your employer faces financial difficulties, you could receive less: This pension scheme is your employer’s responsibility. So, when your employer faces financial difficulties, your retirement income also suffers.
- Inability to access it at 55: It typically allows you to access your retirement income from the age of 60 to 65 years. So early retirement may not be an option.
- Lesser choices in appointing beneficiaries: It typically allows you to pass some retirement money to your next kin. However, you cannot instruct your employer on the same.
Every type of pension scheme has its pros and cons. What drives the selection is the personal situation paired with retirement goals. The DB pension scheme makes sense if you do not want to invest in a private pension scheme and want a definite pension value. Otherwise, you can transfer out and choose more flexible and lucrative options.
If you are in a dilemma, it is advised to consult an expert about your financial situation and ambitions. Also, weighing out different options is a time-tested method to find the best option.