Defined Benefit Pension Schemes

Defined benefit pension schemes have always been regarded as a top hat pension arrangement available to only a fortunate select few. The massive employer costs associated with these pension schemes means that 9 out of 10 private sector schemes have now been closed and there are now no FTSE 100 companies offering them to new recruits. They have now become the preserve of the public sector and a select range of long serving private sector employees.

Quite how precious a commodity they are was highlighted this week by some staggering figures produced by risk management group the Pension Corporation.

In order to replicate the benefits in a public sector defined benefit scheme a private sector employee needs to increase the amount they personally pay into a defined contribution scheme (personal pension or stakeholder pension) by more than 10 times if they want to finish working on a similar retirement income.

In the research a worker aged 35 would need to contribute 55% of their salary to a defined contribution scheme in order to achieve the same retirement income as someone paying 5.1% into a defined benefit scheme. With additional contributions from their employers, both workers could then expect a pension equivalent to half their final salary at age 65.

The employee in the defined benefit scheme does not have to worry too much about fund performance (this is more of a concern to his employer), however for the employees in a personal pension the performance they achieve will have a direct effect on the wealth they enjoy in retirement and more importantly the expenditure they make to achieve it.

Whilst funding for 50% of your final salary will never be a cheap exercise it is amazing how the cost can be reduced just by achieving a little bit more on the performance side, possibly through being more active. An extra 2% per annum will reduce the cost over 30 years by 31%. With an extra 4% per annum that cost is reduced by over half.

Of course this out-performance cannot be guaranteed year in year out but it does illustrate that there is more than one way to solve a shortfall in your retirement planning.