Defined Contribution or Defined Benefit Pension

In a very interesting development and one that I hope is not a harbinger of things to come, all Dutch pension funds will have to make the switch to a new defined contribution (DC) contract which includes a lifecycle system and personal pension pots, following a new pensions agreement between the Dutch cabinet and social partners earlier this month.

The change is “in principle” mandatory for both existing defined benefit (DB) pensions and new accruals, with some exceptions allowed.

A defined contribution plan means that the amount of pension received by the worker is not guaranteed.  Up until the mid-'90s, those employees who had pension plans at work usually had a defined benefit plan. A defined benefit plan means that a worker pays a certain amount into the plan and when they retire they know how much pension they will receive. Beginning in the 90's employers started to move toward with defined contribution plans, these plans are similar to defined benefit plans in that a worker pays a certain amount (the defined contribution) into the plan. However, when the employee retires, the amount of pension they get is determined by the market, and how well the plan is doing. So, the amount of pension is not guaranteed. This plan is better for employers but not good for employees. 

Earlier this month, in Holland,  Social affairs minister Wouter Koolmees had already confirmed pensions would no longer be guaranteed under the new contract, but they would rise and fall in line with markets, shifting risk to participants.

The switch to DC includes the introduction of personal pension pots for all participants to facilitate a projection of members’ “expected pension”, the document said. However, all investments will continue to be managed collectively.

In principle, all 200+ pension funds are required to have moved both existing DB pensions and new pension contributions to the new DC structure by 2026. All pension funds will need to finalize their transition plans by 1 January 2024.

As it becomes harder for governments around the world to deal with the rising number of people living longer and retiring they need to figure out a way to reduce pension liability of the government and the pension plans. The Dutch government move is one that I suspect many other nations will be watching. If it goes ahead without a lot of pushback then I foresee other nations moving, very quickly, in the same direction. 

The Dutch have taken steps to protect older workers with the inclusion of their lifecycle system and the concept of personal pension pots, but others may not see a need to put in the same protections. Something to be aware of as you plan for your own retirement.