Pension and Other Benefit Schemes
This domain tests defined benefit and defined contribution pension design, funding methods, and the actuarial valuation of retirement benefits.
Benefit design
- A defined benefit (DB) scheme promises a pension usually linked to salary and service. A final-salary formula is pension = accrual rate x pensionable service x pensionable salary at retirement. A CARE scheme uses career-average revalued earnings.
- A defined contribution (DC) scheme accumulates contributions in an individual account; the retirement benefit depends on the fund value at retirement.
- Common features include spouse's pensions, indexation, early-retirement reductions, ill-health benefits and commutation of pension for a lump sum.
- Funding methods include the projected unit method, which values benefits accrued to date, and the aggregate or individual-level method, which spreads the cost of future service over remaining working lifetimes.
Worked example
A member retires after 30 years' service with final pensionable salary 600,000. The accrual rate is 1/80 per year of service. The annual pension is (1/80) x 30 x 600,000 = 225,000. If the commutation factor is 12 per 1 of annual pension, commuting the full pension would give 225,000 x 12 = 2,700,000, subject to scheme limits. If the member instead commutes half, the pension falls by 112,500 per year and the lump sum is 1,350,000.
Traps that cost marks
Distinguish pensionable salary from total salary and final salary from career average. Apply the accrual rate per year of service, not per month unless stated. Do not ignore indexation, spouse's benefits or early-retirement factors. In DC schemes there is no promise of a benefit level; investment and longevity risk sit with the member.