Your questions answered

A pension buy-in is an investment where a pension scheme purchases an insurance policy to cover the benefits payable to some or all of its members. This means that the insurer takes on the responsibility for paying the pensions of those members to the scheme, effectively transferring the risk from the pension scheme to the insurer. The scheme retains the legal responsibility for paying the pensions, but the insurer is responsible for funding the scheme so the payments can be made. The scheme transfers assets to the insurer to the meet the buy-in price.

Pension scheme trustees may choose to “buy-out” some or all of their scheme’s expected future benefit payments by purchasing a bulk (ie one covering many individuals) annuity contract from an insurance company. The insurer then becomes responsible for meeting pension benefits due to scheme members (effected ultimately by allocating an individual annuity contract to each scheme member). Following a full buy-out, (ie one covering all scheme members) and having discharged all of the trustees’ liabilities, the pension scheme would normally be wound up.

A pension buy-out involves a pension scheme assigning an insurance policy into the names of the members or other beneficiaries of the scheme. A buy-in is a necessary first step before a buy-out. The buy-out transfers legal responsibility for paying the members from the pension scheme to the insurer. Pensions are then paid directly to members by the insurer rather than by the scheme, and the buy-in ceases to be an asset of the scheme. This process is used to transfer all or part of the liabilities of a scheme to an insurer and is often associated with the winding up of the scheme. It is not normally necessary to make any additional payment to the insurer to move to buy-out.

In a defined contribution (DC) arrangement, a form of lifestyle in which, in the run up to the point at which a member starts to take their benefits, assets are gradually moved fully or mostly into cash. The member will then typically take their pension pot as a single cash lump sum or small number of cash lump sums.

Often used in relation to defined contribution (DC) arrangements, the default option is the fund or mix of funds in which contributions in respect of a member will be invested in the absence of any explicit fund choice(s) by that member. The three broad options members have at retirement are cash, annuity purchase or drawdown.

A deferred member is a person who has benefits in a pension scheme as a result of a previous employment.

A pension scheme in which the primary pension benefit payable to a member is based on a defined formula, frequently linked to salary. The sponsor bears the risk that the value of the investments held under the scheme fall short of the amount needed to meet the benefits. Contrast with defined contribution (DC).

A DB pension scheme surplus occurs when the scheme's assets exceed its liabilities—that is, the total value of promised pension benefits to members. This surplus indicates that the scheme is more than adequately funded, providing a buffer that can potentially be utilised for other purposes. (PLSA) 

A pension scheme in which the sponsor stipulates how much it will contribute to the arrangement for each individual member, which sometimes will depend upon the level of contributions the member is prepared to make. The resultant accumulated fund (or “pot”) of money for each member is a function of the investment returns achieved (net of expenses) on the contributions and how long the money is invested. DC members typically use their accumulated pot for one of three purposes – annuity purchase, cash or drawdown. In contrast to a defined benefit (DB) scheme, the individual member bears the risk that the investments held are insufficient to meet the desired level of benefit. The vast majority of newly established UK pension schemes are defined contribution.

In a defined contribution (DC) arrangement, a form of lifestyle in which, in the run up to the point at which a member starts to take their benefits, assets are gradually switched into an appropriate mix of investments from which the member can source (or “drawdown”) an income while leaving the balance of their pension pot invested to provide future growth and income. In practice, it is common as part of the switching process for up to 25% of the member’s pension pot to be moved into cash which the member can take as a tax-free cash lump sum when they first start to take their benefits, with the remainder being allocated to drawdown.

The value of assets divided by the value of the liabilities as defined by the funding target for a defined benefit (DB) pension scheme at the calculation date.

The value of the assets that is calculated (on a given set of assumptions determined by the trustees) as being required at the calculation date in order for a pension scheme to meet its liabilities.