Contributions in DC vs DB scheme

Discussion in 'CP1' started by Minal Gohil, Mar 28, 2019.

  1. Minal Gohil

    Minal Gohil Member

    Hello,

    Sorry for this rather silly question. Can you please clarify my understanding, in general, on who pays for contributions in a DC vs DB pension scheme?

    DC scheme - The contributions are paid for by the member (some x%) and by the employer (some y%). There could or could not be relationship between x and y%.

    DB scheme - The contributions are paid for by the sponsor, depending on the "funding" level. If the scheme is funded, then the employer will calculate the funding required (I can think of this is as reserves in the context of Life insurance) as the PV of future defined benefits it needs to pay + PV of expenses that will be incurred in administrating the scheme. If the scheme does not have enough funding, it needs to contribute? But this means, the contribution is determined and made periodically.
    Am I thinking this right, directionally at least?

    The primary reason I started to think about this question was the case study 2 in assignment 6. In this question, company X had DB in place, and its contribution rate to the scheme increased significantly over the last 20 years. Which encouraged me to get my fundamentals right!

    Regards,
    Minal
     
    Last edited: Mar 28, 2019
  2. Helen Evans

    Helen Evans ActEd Tutor Staff Member

    Hi Minal

    An occupational DC scheme will most likely have employer and member contributions (although some schemes might be non-contributory, ie contributions only paid by the employer). Some schemes will have matched contributions, eg employer will match the employee contributions up to say 5% of salary.

    A DB scheme is usually primarily or entirely funded by the employer. If it is a contributory scheme, ie the member contributing as well then it is normal for the scheme to be "balance of cost". This means that the member contribution rate is a fixed percentage of salary, say 5% of salary and the employer meets the rest of the cost (so if there were adverse experience then the employer contribution rate would increase but the member would still pay 5%).

    In terms of the contribution rate, it is calculated to meet both the cost of benefit which are being earned each year and to deal with any shortfall in the scheme, wich we can assess by looking at the funding level (ie assets/liabilities). It is common for a regular contribution funding approach to be used, ie contributions are paid over time to meet the cost of ongoing accrual and gradually deal with any deficit. If the contribution rate is increasing this is suggesting an increase in new benefits accruing and/or increasing deficit (for example due to experience being worse than expected).

    I hope this helps.
     
    Minal Gohil likes this.
  3. Minal Gohil

    Minal Gohil Member

    This was very helpful. Thanks a lot!
     

Share This Page