Questions:
What is the difference between a defined benefit plan and a defined contribution plan?

Matt has a defined contribution pension scheme. However, during the year, he introduced a new post-employment plan (the Fund) for its employees as a way of enhancing the benefits they will receive when they retire. Matt makes monthly contributions into the Fund that are equal to a set percentage of the salary cost. Upon retirement, employees will receive annual payments from the Fund based on their number of years of service and their final salary. The Fund is voluntary, and Matt can cancel it at any point.

Matt has a history of paying employees benefits that are substantially above the national average, with annual increases more than inflation. Matt has won many accolades as a 'top employer' and received positive coverage from the national press when the Fund was announced.

Advise Matt on whether the above fund is a defined benefit plan or a defined contribution plan.

Reference answers:
A defined benefit plan and a defined contribution plan are two types of retirement plans with distinct differences:

# Defined Benefit Plan:
- Employer promises a specific benefit amount to employees based on a formula, typically considering salary and service years.
- Employer bears investment risks and guarantees benefits.
- Funding is typically employer driven.

# Defined Contribution Plan:
- Employer contributes a fixed amount to each employee's retirement account, without promising a specific benefit amount.
- Employee bears investment risks and benefits may vary.
- Funding is typically shared between employer and employee.

Defined benefit plans promise a specific benefit, while defined contribution plans promise a specific contribution. The employer's role, investment risks, and benefit certainty differ significantly between the two. It is possible that there will be insufficient assets in the Fund to pay the benefits due to retired employees, particularly if final salaries or life expectancy rise substantially. Matt therefore bears actuarial and investment risk because if he continues with the Fund, he will need to make up for any shortfall.

The Fund should be accounted for as a defined benefit plan.

Although the Fund is voluntary and can be cancelled, Matt has a history of remunerating its employees above the national average as well as a strong reputation as a good and honest employer. Matt therefore has a constructive obligation to continue with the Fund and to ensure that its level of assets is sufficient. As a result of the above, the Fund should be accounted for as a defined benefit plan.