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Group Pensions


The Rationale for Pension schemes

The essential aim of a pension scheme is to make provision for members and their dependants by providing a base for financial security at retirement. Private pensionís provision is regarded as particularly necessary in Ireland, where State benefits are relatively modest. Indeed, the State encourages private pensionís provision by granting generous tax reliefís and incentives to both employers and employees. Pension schemes are therefore a very tax-efficient form of compensation in this country.

It is estimated that about two-thirds of all employees in this country are now members of a pension scheme. This means that employers are increasingly obliged to provide pension benefits in order to attract and retain suitable staff and thus compete effectively in the labour market.

Funding for Retirement Benefits

Looking firstly at retirement benefits, the company has a choice of two fundamentally different approaches to designing the scheme.

The first is to define the benefits that each employee is to receive at retirement. The pension benefit for example would normally be a percentage of the employee's pre-retirement income, and would be related to his/her length of service with the company. The annual contribution necessary to meet the benefits promised is then assessed actuarially, usually being expressed as a percentage of the payroll. Once the scheme is established, the contribution level is subsequently reviewed at regular intervals to ensure that the funding rate is on target to meet the benefits promised. Costs can vary if the scheme's experience is different from that projected at the outset. Schemes which are structured in this way are known as `Defined Benefit' schemes.

The second approach is to define the contributions that the company is prepared to make on behalf of each employee, expressed as a percentage of the employee's pay. The benefits at retirement will depend on the accumulated value of these contributions at retirement age, and will not be guaranteed in advance. From the company's point of view, this `Defined Contribution' has three major advantages over the defined benefit approach, viz.

a)††† Costs are set down in advance, and won't subsequently vary as a percentage of the payroll. This allows the company to budget more precisely. With the defined benefit method, costs can vary according to the scheme's unfolding experience, particularly if investment returns or pay increases are higher or lower than expected.

b)††† Defined benefit schemes are subject to greater statutory regulation than defined contribution schemes. Reporting requirements are more onerous, and regular funding assessments have to be carried out. This extra regulation obviously imposes additional costs.

c)††† In our experience, employees grasp the concept of defined contributions more easily, which leads to a greater appreciation of the extent of the provision being made on their behalf.

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