Defined Benefit Pension Scheme:
Pension plan that commits to paying a specified amount to each employee on retirement, depending on the years of work and salary level.

Defined Contribution Pension Scheme:
Pension plan for which contributions are specified, but the pension received by the employee on retirement is is related to how the funds in the plan have been invested and the return on that investment.

Advantages of DB

•  Guaranteed retirement income security for scheme members on retirement
  
  
• Provides a higher income than DC for the same money
  
  
•  No investment or longevity risk to participants
  
  
•  Cost of living adjustments provided
  
  
• Members are not required to make investment decisions
  
  
• Assists in recruitment and retention of staff retention for the employer

Advantages of DC

• Members have a certain degree of choice as to how much they save
  
  
• Members can benefit from good investment results
  
  
• Individual pension accounts are readily portable between different employers.

Disadvantages of DB

• Transfer between employers can be disadvantageous to employees
  
  
• Not so beneficial to employees who leave before retirement
  
  
• Any deficit in the scheme shows in the employer's annual accounts and can therefore influence the share price of the company and weaken the strength of the covenant between the trustee and the sponsor

Disadvantages of DC

• Value of pension is not predictable
  
  
• Provides a smaller income than DB for the same money
  
  
• Investment and longevity risks are borne entirely by the member
  
  
• Difficult to build a sufficient fund for those who enter late in life
  
  
• Forced early retirement for health reasons or redundancy in times of recession may mean having to accept a very low pension

Which is the more cost effective?

A report from the National Institute on Retirement Security (NIRS) in the US, found that a defined benefit (DB) pension can deliver the same retirement income at 46% lower cost than an individual defined contribution (DC) account. It argues that DB schemes are ageless and therefore can perpetually maintain an optimally balanced investment portfolio rather than the typical individual strategy of down-shifting over time to a lower risk/return asset allocation - resulting in a 5% cost saving. Finally, the report said that DB plans achieve higher investment returns compared to individual investors because of professional asset management and lower fees - resulting in a 26% cost saving.

In the UK similar conditions have been confirmed to apply to the UK by Stephen Nichols, the Chief Executive of the Pensions Trust writing in Professional Pensions, May '11. More recently a study by Con Keating, head of research at Brighton Rock Group, says that "it is a popular delusion that DB schemes are too expensive" (23 Sept. '11) Full report here.

Over recent years the cost for employers of providing a DB pension scheme has risen for many reasons such as the increase in longevity and this has lead to their closure and replacement largely by DC schemes. However the amount of money paid into DC schemes by employers is now much lower than the amount they used to pay into DB schemes so inevitably this will lead to lower quality pensions for employees.

Can DB schemes be made affordable? Is it possible to devise a compromise between DB and DC? The OPA maintains that the answer to both questions is yes. Read on