DC and DB pensions: advantages and disadvantages?

As an employer, choosing between defined contribution (DC) and defined benefit (DB) pension schemes for your workforce is a critical decision.

With 88% of employees participating in workplace pensions, your choice will have a crucial impact on their retirement plans. 

So, do you know which pension scheme is best for you and your employees? 

DC and DB pensions come with their advantages and disadvantages, making the decision-making process complex. 

However, seeking expert advice from our Pension Consultation Service can help.

But first, what are DC and DB pensions?  

DC and DB pensions: What’s the difference?

DC and DB pension schemes represent two distinct approaches to retirement savings. 

A DC pension is the most common type of pension used in workplaces.

Employees contribute a portion of their salary to an individual account. Contributions can be made by the employee, the employer, or both. The eventual retirement income is based on the contributions made and the investment performance of the funds within the account.

DB pensions (also known as ‘final salary’ pensions) are typically workplace pensions which provide a guaranteed annual income starting at a set retirement date, often at ages like 65 or 60. 

The amount received is determined by factors including salary, length of employment, and the pension scheme's rules.

The advantages of DC pensions explained

1. Keeping Costs in Check

DC pensions are a win for employers when it comes to figuring out costs. You know exactly what you’re going to pay since it's set up front, making it easier to budget and plan. This allows for better budgeting and financial planning, especially for small and medium-sized businesses with limited resources.

2. Easy Administration

Compared to the old-school DB pensions, DC pensions are a breeze to manage. All employers have to worry about is handling the contributions and picking out investment choices, cutting down on a lot of paperwork and hassle.

3. Giving Employees the Reins

DC pensions let employees call the shots on their retirement savings, making it easier for them to fit their pension into their life plans. When combined with a robust employee retention policy, this flexibility can make employees stick around longer because they feel like they're getting a good deal on their pension. 

The disadvantages of DC pensions

1. Shifting the Investment Risk

With DC pensions, you are transferring the risk to your employees. It’s like you’re saying "You handle the investment risk," since what employees end up with when they retire depends on how their investment accounts perform. This means there could be a lot of ups and downs in how much cash employees have for retirement. This might not be great for team morale.

2. Teaching Employees the Ropes

As a result of shifting the risk, conscientious employers need to put effort and resources into teaching their employees how to make smart investment choices. Your HR department will have to do a lot of work around educating employees. 

‍3. Uncertain Retirement Cash

DC pensions give employees some freedom to choose, but there's the catch of maybe not having enough money for retirement if the investments don't do well or if they didn't save enough. If employees' retirement funds aren't looking too good, employers might get pushback from their team. 

The advantages of DB pensions explained

1. Guaranteed income

DB pensions are like a promise to employees that they'll get a steady flow of cash when they retire, giving them a solid financial cushion and peace of mind. It's a big plus that helps attract and keep good people.

2. Employer responsibility

In the DB pension world, it's the bosses who take on the risk and the job of making sure there's enough money for the promised retirement funds. Employees do not have to worry about making smart investment decisions. 

3. Workforce stability

DB pensions are pretty good at making employees want to stay for the long haul, helping businesses keep a stable and loyal team. If your industry has difficult working conditions or involves high levels of risk, then guaranteed retired income can help you keep hold of employees for the long term. 

The disadvantages of DB pensions

1. Cost Rollercoaster

DB pensions can give employers a bit of a headache with their costs, which can go up and down like a yo-yo, especially during economic downturns or periods of low investment returns. Keeping up with the cash needed can be tough.

2. Increase Administration

Running a DB pension means drowning in paperwork, from figuring out pension numbers to keeping up with rules and chatting with employees about their benefits. It's a lot and can take up a bunch of time and resources.

3. Jumping Through Hoops

DB pensions are subject to stringent regulatory requirements. From making sure there's enough money in the pot to filling out all sorts of reports, you must ensure compliance to avoid legal risks and penalties.

What is best for your business?

Ultimately, the decision between DC and DB pension schemes requires careful consideration of the specific needs and circumstances of your business and navigating these complexities can be daunting.

We understand. 

That’s why we’ve created The Employer’s Guide to Workplace Pensions. This handy guide helps you to:

• Understand the typical lifecycle of a pension scheme.
• How to get your employees engaged.
• Types of pension schemes available.
• Issues you need to consider at each stage of your lifecycle.
• Administration and record-keeping advice.

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