DB schemes essentials
A defined benefit or DB scheme is a scheme in which the benefits are specified in the scheme rules. Most commonly, the benefits are related to members’ earnings when leaving the scheme or retiring, and the length of pensionable service.
A member normally pays contributions to the scheme based on their earnings and the sponsor is responsible for the balance of the cost of providing the benefits. All assets of the scheme are invested by the trustees to ensure that the scheme is able to pay the contributions as they fall due. The trustees and the sponsor will need to work together to ensure that a DB scheme is properly run.
The following are all types of DB schemes:
- Final salary schemes – where a member typically accrues 2/3rds of final salary at the date of retirement or leaving service after 40 years’ service;
- CARE schemes – where a member accrues a pension block for each year of service which is then increased by an inflationary measure, such as CPI, rather than being tested against final salary; or
- Cash balance schemes – where the scheme provides a lump sum which the member can use to buy an annuity expressed as a formula linked to the member’s final pensionable salary.
Sackers act for clients with all of these types of schemes. We prepare documentation and advise on benefit structures and payments and on the proper and effective governance of schemes.
The heart of the trustees’ role is to ensure that the scheme is administered correctly and that the scheme is sufficiently well funded to pay all the benefits as they fall due.
Trustee duties include managing and collecting contributions from the sponsor and the members. The funding arrangements for a DB scheme are governed by the scheme funding regime and are tightly regulated by TPR. The trustees are also responsible for deciding the investment strategy– an increasingly complex role.
For more details of the powers and duties of trustees, please read our Beginner’s Guide.
In a DB scheme the sponsor makes a promise to pay a pension of a certain level (depending on the type of scheme). This promise is a financial commitment. The sponsor will need to work with the scheme trustees to ensure that statutory funding requirements are met and that the scheme can honour its financial commitments.
The employer covenant is the extent of an employer’s legal obligation and financial ability to support its DB scheme now and in the future. An employer covenant can change swiftly as a result of economic circumstances or particular events. The covenant will affect the assumptions that trustees make about the amount of money that the scheme needs.