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Instituional Investment

In: Business and Management

Submitted By anniexss
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Differences between defined-benefit and defined-contribution pension schemes and the trend in these two pension schemes
This essay focuses on the differences between defined-benefit and defined-contribution pension schemes as well as alternative reasons why defined-contribution pension schemes are becoming more and more important. Defined-benefit and defined-contribution pension schemes are two basic types of pension schemes. (Clark & Melinda, 1999) Defined-benefit schemes promise a particular benefit at retirement whereas defined contribution schemes only prescribe rules of contribution saving into individual accounts. In general, the size of defined benefit pension is determined by the final salary and the length of service while the income of defined contribution pension scheme is based on the value of the fund at retirement. In the UK, Both employer and employee contributions to the pension schemes are tax-deductible, even though the pension itself is taxable. (Redhead, 2008)

Defined-benefit schemes, also known as final-salary schemes, are typically provided by employers for their employees. The schemes promise to pay a specified level of income at retirement. The income is worked out according to the number of years in the scheme and the final salary at retirement. The schemes would provide the accrual rate, typically 1/60th or 1/80th. (Callaghan, et al., 2012) For example, a person’s salary at retirement was £24,000 and he has worked for 40 years until retiring. In a 1/60th scheme, he would receive a pension of: 1/60×£24,000×40=£16,000 a year. Normally, if members of DB occupational pension schemes want to draw the pension, they need wait until the age of 60 or 65. Otherwise, there would entail a reduction of around 5% per year of early retirement. For instance, if the normal retirement age is 60, the retirement at 62 would lead to an actual reduction...

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