This is the fourth article in the series on whether to swap from a defined benefit to a defined contribution scheme.
Recently I have seen a number of proposals made to employees, giving them the option between remaining with a defined benefit scheme or moving to a defined contribution scheme.
The two main lures are:
* Higher group life and disability benefits; and
* Receiving a portion of surplus from the defined benefit fund.
As I explained last week one of the reasons why group life and disability benefits are higher in a defined contribution fund is that if you die tomorrow and are relatively young, there may not be sufficient money for your family to draw a reasonable income. A higher group life benefit helps plug the hole.
In other words depending on how the group life benefit is structured the benefit may not be as good as it appears and you and your dependants could be left short if your accrued savings in your defined contribution fund are still very low.
Most existing defined benefit schemes offer a multiple of between one and two years of your existing salary or wage as the benefit if you die. Some defined contribution schemes are offering a multiple of four or five times your salary. But with the defined benefit scheme you receive a virtually guaranteed pension based on your expected final salary.
However the problem does not end there. What you are being offered now is not necessarily what you will receive.
Aids poses a significant threat to retirement funds and particularly to group life and disability benefit schemes.
As Aids takes its toll an increasing number of people will seek disability benefits at a younger and younger age and finally early payment of death benefits. Employers will be faced with three choices:
* They can increase the amount they pay in premiums for group benefits;
* They can reduce the level of the group life and disability benefits; or,
* They can reduce the amount they contribute to your retirement benefits.
Most employers decide on how much they will contribute in total to both retirement and group life benefits in defined contribution schemes - and then they stick to that figure.
So for example say your employer contributes an amount equal to 10 percent of your monthly salary towards retirement and group life benefits. Of this, for simplicity sake, say nine percent goes towards your retirement benefit and one percent goes towards the group life benefit premium.
Then Aids starts pushing up the claims against the group benefit. The life assurer justifiably increases the premiums. Your employer cannot afford the new premium. The choice then is to either reduce contributions to the group life benefit or reduce the proportion that is paid towards your retirement fund.
For example, say your benefit is currently four times your current salary. This is could be dropped to be three or even two times your current salary as a benefit.
The other option is for your employer to adjust what goes to what.
Take the original example of your employer contributing 10 percent to your defined contribution retirement fund and group life benefits. Your employer could reduce the amount paid to your retirement to say an amount equal to 8,5 percent of your salary and increase the contribution to the group life benefit to1,5 percent. This will have a considerable impact on your ultimate retirement benefits. Half a percentage point of your salary may seem like a little, but over time, with the effect of compound interest, it builds up considerably the amount you will save towards your retirement.
Group life benefits for defined benefit schemes can also be reduced but employers will have a far more difficult job justifying this if the group life benefits for defined contribution schemes are much higher.