A Defined Benefit Scheme is one in which the benefits are defined in advance. For example, a scheme may provide a pension of 1/60 of final salary for each year of service so that an employee completing 40 years of service can expect a pension of two thirds of final salary.The benefits paid to any individual are not directly related to the contributions paid to the scheme. But rather typically, the benefit will be based both on an employee’s salary and service with an employer.

A Defined Benefit Scheme can be operated in two ways:

Management Contract basis (Managed Scheme)
The cost of providing the benefits is not known precisely until all the benefits cease to be paid. Estimates can be made in advance on the basis of assumptions about future investment returns, employment patterns and inflation to determine regular contributions for funding purposes.

Insurance Policy
The cost is calculated on a yearly basis with payments of annual contributions. The benefits payable are guaranteed as and when they fall due.

Members may be required to contribute a percentage of their salaries towards the cost of the Defined Benefit provision. The employer will then meet the balance of cost.

Fixed member contributions are most common but it is also possible for the members’ rate to be variable. The total contribution rate of employer and member usually varies depending on how the funds held compare with the estimated cost of the benefits. At times, an employer may not be required to contribute at all.