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Defined Benefit or Defined Contribution – how would members choose their pension benefits?
DB or DC – a member's perspective
In reality choosing pension benefits is not an option available to many people. Paul Moffatt, Senior Manager at KPMG in the UK, considers what members might choose if a full array of options were available.
I’ll start by considering the traditional extremes of Defined Benefit and Defined Contribution, assuming both options are equally as generous. To identity a winner, let’s ask our potential scheme member some questions:
- Would you value flexibility in relation to your benefits?
- Would you like to be able to choose different levels of contributions to suit you over time?
- Would you like to be able to draw on your benefits in a way which meets your varying needs in retirement?
- Would you like control over where your money is invested?
- Would you like to be able to pass on any residual value to your relatives on death?
I would expect that the answer to these five questions to be ‘yes’. In this case the DC scheme is the clear winner. But what if we had started with the following questions instead?
- Would you like a degree of certainty in relation to your retirement benefits?
- Would you like guaranteed increases in retirement?
- Would you like your pension to be guaranteed to be paid until you die?
- Would you like your employer to underwrite all the risks in relation to your benefits?
- Would you like complex investment decisions to be made by trustees who have a duty to act in your best interests?
If the answer to these questions is also “yes” perhaps the DB scheme is the better option for our potential scheme member.
In reality many people would find it difficult to answer some of these questions as both defined benefit and defined contribution have their benefits and challenges. And this goes to show the crucial role employers have in helping their staff understand this complex area and to consider the benefits which might be suitable for different sections of their workforce. It is unlikely that one DC (or DB) option will be suitable for all employees and we looked at some of the reasons for this in my last article 'Living pension: achieving financial inclusion'. For many people a pension might not be the right option at all and employers should also consider this when developing their total reward strategy.
Considering a young graduate entering the workforce helps to illustrate why, as many are faced with a large amount of debt and high housing costs. A priority for some graduates may be to save up for a house deposit or to pay down debt. Is it fair to exclude these people from some of the value available from the employer because joining a pension scheme it not a priority for them?
From a total reward perspective it makes sense to allow such individuals with different priorities to choose between cash, savings (such as a LISA) or pension to suit their circumstances. For those opting for a pension it could be the traditional extremes (DB or DC) but also other options, as considered in my recent article 'Pensions: a sustainable future for society'.
The boundaries between pension and other savings options are starting to blur. Employers who embrace a new more flexible world will make themselves more attractive to the talent needed to drive their businesses forward.
For further information, please contact Paul Moffatt.
