What is a “defined benefit” or “last salary” pension? Investing Explained

In this series, we break the jargon and explain a popular investing term or topic. Here it is “defined benefits”.

comic? David Beckham?

Nothing so glamorous. It is the acronym for “defined benefits”, a type of pension.

DB plans are sometimes known as ‘final pay’, the traditional type of company pension plan, based on the employee’s years of service and, as the name suggests, pay-as-you-go. end of his career.

Sometimes, to further muddy the waters, the payout is tied to an employee’s average career salary, not their last paycheck. Britain has around 5,000 DB schemes, often referred to as ‘gold-plated’ because of the guaranteed and generous pensions provided.

What is a DC schema?

‘Defined contribution’, also known as ‘purchase of money’. With this type of company pension, what you receive in retirement is based on the value of the pot made up of your contributions and those paid by your employer during your career. These are invested in stocks and other assets.

Where can I get a DB plan?

Only a few workers now have access to a DB scheme. Most private sector plans are closed to new members. About 79 per cent of employees contribute to a company pension scheme, but only 8 per cent are affiliated to a DB scheme. Companies found they could no longer afford to keep DB plans open. They are good for employees, but involve high risks and costs for employers.

However, millions of people are affiliated with existing schemes, either receiving a pension or having the right to future retirement income.

Have DB diets made the headlines?

Probably more in recent weeks than in their entire history. The crisis hit the DB sector following former Chancellor Kwasi Kwarteng’s mini-budget.

Many DB funds invested through complex liability-driven investing (LDI) programs, which aim to increase returns, but nearly imploded due to rising interest rates.

What happened?

LDIs try to match liabilities in part by investing in gilts (fixed-tranche government bonds), against which they borrow or “lean” to buy even more gilts or other assets. When the Kwarteng measures torpedoed gilt prices and pushed yields higher, the funds were forced to sell in response to calls from their lenders for more collateral.

To avoid the collapse of certain funds – which were “a few hours away from disaster” – the Bank of England intervened.

Should I be worried about my diet?

The dangers of LDIs do not appear to have been widely recognized. But the Bank of England is working with the Financial Conduct Authority watchdog and the pensions regulator to “ensure that enhanced standards are put in place”.

In the mirror world of pensions, nothing is simple and the jump in gilt yields has improved the funding position of DB schemes, as it has reduced the bill for paying pensioners income. If a fund is in trouble, the employer must step in and, as a last resort, there is also a pension protection scheme that will partly protect members’ savings.

And the prospects for the DB regimes?

More companies may be tempted to enter into “buy-out” agreements, in which they transfer their pension promises to an insurance company, which assumes the liability.