DB vs DC: A business guide to pension plans

Understanding workplace pensions is pivotal for safeguarding you and your staff’s future financial wellbeing, despite the often complex terminology and daunting criteria. For employers, providing a robust pension is no longer just a legal requirement, but can be a strategic tool for both talent acquisition and retention, by offering a tangible demonstration of long-term commitment to their employees.

The type of workplace pension scheme an employer uses has far-reaching implications for managing benefits, contributions, and retirement provisions. This guide examines the two most common types, Defined Benefit (DB) and Defined Contribution (DC), to help businesses understand their differences, similarities, and suitability.

Core Differences in Pension Calculation

While both DC and DB schemes aim to provide financial security in retirement, they operate on fundamentally different principles regarding how the final pension is calculated.

DB Schemes

DB schemes require minimal involvement from members, other than paying monthly contributions from their salaries, which can be appealing to employees who prefer not to manage their retirement investments directly. Historically, such schemes have often been considered a more desirable and ‘safe’ option, providing a secure lifetime income and underwritten by UK law. However, these pensions are becoming less common due to increased running costs for employers. 

As EWM Financial Planning highlights, “DB schemes are mainly used in the public sector, and pensions work on a benefits package dictated by the number of years and income with that specific employer. The income on retirement is effectively guaranteed.”

The specific amount of contributions an employee makes does not directly dictate their final payment; the pension is calculated using a predetermined formula. This means instead of having a pot of money at retirement, contributions have built up an annual amount that’s paid annually, and increases with the cost of living. Similarly, depending on when an individual begins paying into a DB pension scheme, they may have an automatic tax-free lump sum as part of the pension perks.

DB schemes typically come in two varieties:

• Final salary pensions: Based on your salary and length of membership at retirement
• Career Average Revalued Earnings (CARE): Based on your average salary throughout your entire membership

DC Pension Schemes

DC schemes, sometimes called ‘money purchase’ pensions, operate more like savings accounts where both employee and employer contributions are invested. The employer and individual pay straight into the account, which is then invested in stocks, shares, and bonds to increase the overall amount in the account. 

As money is invested, the value of pensions can go up or down, depending on the performance of investments. The final accumulated pension pot is then used to fund retirement. 

These schemes offer several benefits:

• Greater flexibility in how and when the pension is accessed
• More autonomy and control over investment choices
• Potential for higher returns if investments perform well
• Wider beneficiary options upon death

That said, this flexibility comes with higher levels of risk; members must make regular, conscious decisions about their investment strategies. Given the market is prone to fluctuations, it’s possible pension value could be lower than anticipated.

Which Type of Pension Scheme Works Best for Your Business?

The choice between DB and DC schemes often reflects the financial capacity and priorities of the business.

Given the financial commitments and long-term liability involved, DB schemes typically work well for the following companies:

• Public sector organisations with stable, long-term funding
• Large corporations looking to attract and retain talent
• Organisations prioritising employee security over contribution flexibility

Conversely, DC schemes, given their administration simplicity and ability to adjust contribution levels, are better suited for:

• Startups or growing businesses that need contribution flexibility
• Companies with younger, more mobile workforces
• Organisations wanting predictable pension costs

Guiding Pension Decisions

For any business, ensuring the pension scheme is fit for purpose and reflects the current needs of the organisation and its staff is a continuous responsibility. With the average retirement age in the UK rising annually, actively seeking staff feedback on pension provisions and voluntary contributions is a strategic priority.

• Evaluate Workforce Needs: Consider the demographic of your workforce. Younger, more mobile employees might prefer the flexibility and control of a DC scheme, while staff approaching retirement may value the security of a DB-style provision. 
• Strategic Fit: Whether you are looking to control costs or offer the most secure benefit package, your scheme choice should align with the company’s financial capacity and long term goals.
• Professional Advice: Whenever considering a scheme change or evaluating the current scheme’s security, the Pension Protection Fund offers a valuable source of information, but should not replace professional advice. You should consult with a regulated, FCA-approved financial adviser before making any significant decisions.

By understanding the fundamental differences in risk, structure and cost between DB and DC schemes businesses can move beyond mere compliance and proactively make smart decisions that will benefit all parties. Making informed pension decisions not only fulfills legal obligations, but also strengthens employee loyalty, providing the cornerstone to a long-term workforce strategy.