Defined Benefit

DB plans (often known as final salary schemes), are trust-based occupational pension schemes which specify the level of benefits which will be payable on retirement, death or leaving the relevant company’s employment. Normally, the resulting pension will be calculated by reference to the employee’s final salary and years of service.

Defined Contribution

DC plans (often known as money purchase plans) are pension arrangements under which the eventual pension benefits are not specified but the employer and the employee each agree to contribute to a fund at a specified rate (e.g., 5% of salary for each).

DC plans can either be trust-based or contract-based. DC “master trusts” are regulated and commercially-run pension schemes designed for various employers to participate in.

The automatic-enrolment regime prescribes eligibility, participation and a minimum level of pension benefits for all qualifying UK employees (whether in DB or DC arrangements). Most employers now provide DC arrangements for current employees, and DB pension schemes tend to be legacy arrangements. 

It is important to identify early on whether there is a DB pension plan associated with an in-scope entity as the plan can impact deal timings, purchase price, notifications and corporate reorganisation steps, including any cash repatriation elements. It will also be key to avoid inadvertently triggering any pension debts or the wind-up of a DB plan and/or weakening the employer “covenant” (meaning, broadly, “financial strength”) supporting the plan. The last event could require mitigation if not to fall foul of the UK Pensions Regulator's anti-avoidance regime (see below).

Since 2005, in situations where a transaction materially weakens the employer covenant of a DB plan, the Pensions Regulator has had the power to impose substantial financial penalties on parties to the transaction and other group companies (and potentially directors and other company officers). However, these powers were not used widely and so the regime was changed to be “clearer, quicker, tougher” from October 2021, when significant new powers were introduced aimed at protecting DB pensions. The changes included the introduction of new criminal offences (unlimited fines / 7 years’ imprisonment) in certain cases of wrongdoing and wider powers for the Pensions Regulator to impose liability on other group companies (up to buy-out deficit) and up to 1 million GBP fines. A new notification regime is expected to be introduced to give the Pensions Regulator greater oversight of corporate activity affecting UK companies supporting DB plans.