DEFINED CONTRIBUTION VS DEFINED BENEFIT PLANS

A defined contribution plan is a pension plan whereby an employer pays fixed contributions into a separate fund and has no legal or constructive obligations to pay further contributions. Any actuarial and investment risks are assumed by the employee or third party. The employer is not required to make up for any shortfall in assets.

All plans that are not defined contribution plans are deemed to be defined benefit plans. If an employer cannot demonstrate that all actuarial and investment risks have been transferred to another party and its obligations limited to contributions made during the period, then the plan is a defined benefit plan. An employer's obligation under a defined benefit plan is to provide the agreed amount of benefits to current and former employees.

In a defined benefit plan, if investment returns are poor or costs increase, then the employer has to either make adjustments to the plan or increase contribution levels. Alternatively, if investment returns are good, then contribution levels could be reduced.

In a defined contribution plan, it is the scheme members who are shouldering the risks. If they fail to take action by increasing contribution rates when investment returns are poor or costs increase, then their retirement benefits will be lower than they had planned for.

For defined contribution plans, the cost to be recognised in the period is the contribution payable in exchange for the services rendered by the employees, reduced by any payments made during the period. No actuarial assumptions are required to measure the obligation or the expenses, and there are no actuarial gains or losses. If payments have been made in excess of those required, then the excess is a prepaid expense to reduce future contributions or will be refunded.

For defined benefit plans, the amount recognised in the statement of financial position should be the present value of the defined benefit obligation, as adjusted for unrecognised actuarial gains and losses and unrecognised past service costs, and reduced by the fair value of plan assets at the reporting date. If the balance is an asset, the amount recognised may be limited under IAS 19 Employee benefits.